Penn Virginia Resources: When Bad News Is Good News

Oct. 7.10 | About: Penn Virginia (PVR)

When on vacation, except for spending 3 or 4 hours daily on our clients’ portfolios and keeping tabs on world markets, I don’t do much other business-related stuff – like writing articles for SA. But I received an important question from a reader who purchased Penn Virginia Resources (NYSE:PVR) based upon one of my articles and asked if I agreed with Zacks’ analysis of short-term problems to come at PVR. Since many other readers may have also agreed with my examination of PVR and purchased it, I think the only responsible response is to share my reply.

Here is Zacks’ take:

Penn Va. Downgraded to Underperform

By Zacks Investment Research|Oct 6, 2010, 2:03 PM|Author's Website

We recently moved to an Underperform rating for Penn Virginia Resource Partners L.P. (PVR), on expectations of a significant dilution of cash distribution stemming from the partnership’s announcement to merge with its general partner, Penn Virginia GP Holdings L.P. (NYSE:PVG).

Despite this near-term fear of dilution, we like Penn Virginia Resources for its diverse coal reserves and leases, located in four different producing basins: Central Appalachia (73%), Illinois (20%), Northern Appalachia (3%) and the San Juan Basin of New Mexico (4%).

Penn Virginia Resource’s coal-royalty business generates revenues by leasing its coal reserves for a royalty payment. Additionally, we favor earnings from the partnership’s Midstream business, which helps diversify its low-risk coal royalty business, benefiting from its hedging strategy.

We believe the partnership’s royalty structure allows for asset and producer diversification, while it eliminates the direct exposure risks that coal mining companies typically face, namely mine operating costs and risks, environmental liabilities and labor relations challenges.

Penn Virginia GP Holdings holds a 37.6% stake in Penn Virginia Resources. The merger between the two partnerships involves completion of 100% equity consideration. The merger transaction would result in PVR owning its general partner and the cancellation of PVG’s incentive distribution rights (IDRs) and L.P. units owned. Furthermore, the merger involves the issue of roughly 38.3 million new PVR limited partnership units and the cancellation of about 19.6 million PVR limited partnership units owned by PVG.

Though the merger would reap profits for PVR in the long term and benefit from significant reduction in the cost of capital, we expect the transaction to be dilutive to the partnership’s distributions in the near term, affecting investor sentiments. As a result, we expect the share price to lose much of its sheen in the near-term, keeping investors away from the stock for the time being.

I responded to the gentleman who wrote me:

I am constrained -- and rightly so -- from commenting on whether a particular investment is "right" for a non-client. (The "Know Your Customer" rule under which, as an SEC-registered advisor, we operate.)

However -- I am able to comment on both the news item and Zacks' take on it. For me, as a long-term investor, the news is great. Magellan recently did the same thing and fears of it reducing its distribution in the short term were overblown. Long term, what PVR is doing makes eminent sense to me!

Short term, Zacks may be right. Because many investors look only at the current month's yield, without doing any further research, many will be tempted to sell as they see what they mistakenly believe is a "trend" of lower distributions.. I personally, and for our clients, will use this opportunity if it presents itself to add to our PVR holdings. For those who want to try to time the possible short-term decline and what I believe will be the considerably better long-term outlook, they may want to sell half their holdings -- at a nice profit! -- and re-enter IF the pullback takes place. If not, you'll still have half your position as a long-term holding.

The bottom line for me is that we have already taken profits on 50% of our position as the market has roared into what I believe is yet another bubble. PVR will not escape a market decline, but this particular news item I see as a plus, not a minus. That’s why we have a strong cash position right now. It is exactly the companies like PVR – with solid management, great cash flow, and superb long-term prospects – that we want to buy if both a market contraction and some alleged (short-term) “bad news” strikes at the same time. If either happen, we’ll buy more. If both occur at the same time, we’ll buy lots more!

Disclosure: We and those clients for whom it is appropriate are long PVR -- and lots of cash!

Disclaimer: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund only to watch it plummet next month.

We encourage you to do your own research on individual issues we recommend for your analysis to see if they might be of value in your own investing. We take our responsibility to proffer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.