Legacy Reserves: Positive Cash Flow Expected In Future Years

| About: Legacy Reserves (LGCY)

Summary

Legacy Reserves suspended its common and preferred unit distributions.

It is likely to deliver positive cash flow over the next few years (potentially in the $200 million to $300 million range).

However, it is also likely to violate its credit facility covenants. Much of the positive cash flow will likely go towards reducing credit facility borrowings.

Common unit distributions are likely suspended for a while, while preferred unit distributions probably require closer to $65 to $70 oil for a reinstatement. Preferred distributions are cumulative.

Legacy can generate positive cash flow at relatively low oil and gas prices. It also has a high leverage ratio even at $60 oil though.

Legacy Reserves (NASDAQ:LGCY) recently suspended both its common and preferred unit distributions amidst low commodity prices. It does look likely to deliver positive cash flow (perhaps $200 million to $300 million over the next few years). However, much of that cash flow will likely go towards paying down its credit facility, which has a secured debt to EBITDA covenant that is likely to be violated. Legacy can probably get that covenant relaxed, but would still need to put a significant amount towards credit facility repayment. While Legacy should have enough cash flow to pay a decent sized distribution, it seems likely that lowering debt and getting itself into a position to refinance in a few years would take priority.

2016 Cash Flow Estimates

I've modeled 2016 cash flow, with production assumed to be 47,000 BOEPD. The split is 26% oil, 6% NGLs and 68% natural gas, similar to early November levels. Lease operating expenses are pegged at $10.50 per BOE as per Legacy's guidance for $11.00 to $11.50 per BOE in Q4 2015, followed by a further reduction in Q1 2016.

This includes $37 million in capital expenditures as per Legacy's 2016 capital budget. Legacy mentioned that it shouldn't take significantly more than $30 million to $35 million to keep production flat, so I am assuming that $37 million is sufficient.

2016 Cash Flow (In $ Millions)

Natural Gas/Oil

$30

$40

$50

$60

$2.00

-$5

$32

$68

$104

$2.50

$14

$50

$86

$122

$3.00

$33

$69

$105

$142

$3.50

$52

$87

$123

$160

Click to enlarge

The result is that Legacy's cash flow in 2016 should be positive under most circumstances. $40 oil and $2.50 natural gas would result in an estimated $50 million in positive cash flow.

2017 and 2018 Cash Flow Estimates

If we use the same production levels, costs and capital expenditures for 2017 and 2018, the result would be $25 million in estimated cash flow in 2017 with $40 oil and $2.50 natural gas, and $125 million in estimated cash flow with $60 oil and $3 natural gas. Legacy does have some joint ventures that should allow it to either increase production or reduce the capital expenditures required to maintain production at 47,000 BOEPD. However, it may take Legacy a few years to gain full benefit, as the time until it gains a greater working interest in the wells depends on commodity prices.

2017 Cash Flow (In $ Millions)

Natural Gas/Oil

$30

$40

$50

$60

$70

$2.00

-$35

$6

$46

$86

$128

$2.50

-$15

$25

$65

$105

$147

$3.00

$5

$44

$85

$125

$166

$3.50

$24

$63

$103

$145

$185

$4.00

$43

$84

$124

$164

$205

Click to enlarge

By 2018, Legacy Reserves still has a substantial amount of natural gas hedges at $3.36, but only a very modest amount of oil hedges. At $60 oil and $3 natural gas, it would produce $116 million in positive cash flow, while $70 oil and $3.50 natural gas would increase this to $178 million.

2018 Cash Flow (In $ Millions)

Natural Gas/Oil

$30

$40

$50

$60

$70

$2.00

-$51

-$8

$35

$77

$121

$2.50

-$32

$11

$54

$96

$140

$3.00

-$12

$30

$73

$116

$159

$3.50

$8

$49

$92

$135

$178

$4.00

$27

$70

$112

$154

$198

Click to enlarge

Debt Position

Legacy will probably have a couple hundred million or more in positive cash flow over the next few years. However, it seems that there is a good chance that much of that cash flow will go to reduce its credit facility borrowings. The credit facility currently has a covenant requiring secured debt to EBITDA to be no more than 2.5x. With $620 million in credit facility borrowings in Q3 2015, it appears likely to have secured debt to EBITDA at around 2.5x to 3.5x by the end of 2016, thus necessitating a covenant relaxation if there are no asset sales.

Legacy's debt is a concern, with debt to EBITDA still likely close to 6x in a couple years with $60 oil and $3 natural gas. Legacy does have the ability to pay down some of its debt over time, but if oil stays around $50 to $60 for a while and natural gas is near $3, its leverage ratio will still be quite high.

Conclusion

Legacy Reserves should be able to generate positive cash flow over the next few years now that it has suspended its preferred and common unit distributions. However, due to its high debt levels and significant amount of borrowing under its credit facility, the positive cash flow appears likely to be applied to reducing credit facility borrowings. The common unit distributions are probably not going to be reinstated for a long while. Legacy would need to be comfortable about its secured debt ratio and its ability to refinance its future debt maturities, as well as pay off the cumulative preferred distributions first. The preferred units may see a distribution paid if oil gets back to the $65 or $70 range in my opinion.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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