Vanguard Natural Resources Q2 Earnings: Smart Decisions All Around

| About: Vanguard Natural (VNR)

Summary

The market didn't care much for Q2 earnings, as debt troubles have not been solved.

We learned that the management made two smart decisions.

Increased hedging positions will increase the reliability of future cash flows, which has been deteriorating.

Capex was lower than expected, but 2016 budget remained the same.

Short-term outlook remains positive; long-term outlook has yet to be determined.

Commodity prices rose sharply in Q2, but Vanguard Natural Resources (NYSE:VNR) is still in a precarious situation. While Q2 results weren't public until last week, investors have been aware of the company's debt troubles (read Meltdown Reflects Reality) for a while, which is why the market didn't care much for the earnings beat ($0.24 actual vs. $0.15 consensus). As I discussed in my previous article, the company is still curing its borrowing base deficiency, which is being reduced at a monthly rate of $17.3 million. Since the end of Q2, the company has made another payment, reflecting my confidence in the company's short-term outlook.

While the long-term outlook remains grim due to the pressure on oil prices (read Oil Can't Go Higher), the most important thing right now is survival, and the management has been doing a very good job. If the company can't survive the current trough in the commodity cycle, there is no future for equity holders. Q2 results are backward looking, so they won't save the company if oil (NYSEARCA:USO) continues to decline, but the management did do two things that secured a brighter future: established more hedges and lowered capex.

Hedges

The company added 22,500 MMbtu/day of natural gas (NYSEARCA:UNG) swaps at an average price of $3.15/MMbtu for production during the first half of 2017 and also another 25,000 MMbtu/day of swaps for the second half of 2017 at a price of $3/MMbtu. This will strengthen the reliability of the company's future cash flow, which has been deteriorating as discussed in my previous article about the company's hedges (read Deterioration Of Hedges).

It's important to understand that the management did not "create value" here, as they don't control the commodity price; however, what's important is that they recognized the company's financial situation and were aware enough to take advantage of the futures curve. If the curve shifts, the opportunity may not present itself again. Nevertheless, the management did set up those hedges, and that should be celebrated.

Capex

The management previously planned to spend $22 million for the quarter, but they managed to cut this number down to $15 million. Despite this decrease, the 2016 capital budget did not change. This implies potentially higher capex in Q3 and Q4. The high end of the range remained at $73 million, which was the target that was updated in May in conjunction with the announcement of the SCOOP/STACK asset sale. Capex reduction isn't meaningful if production can't keep up. During Q2, the management accomplished this without significantly impacting production (only a 1% decline quarter over quarter).

The management has not yet revised estimates, but I believe that they have the flexibility to further reduce capex if the need arises. The company is planning to spend roughly 50% of the balance of the capex budget on Pinedale, where the company is still actively drilling. So if push comes to shove, these drilling projects can be abandoned.

Conclusion

Second quarter results show that the management has been making the right decisions that will extend Vanguard Natural Resources' life expectancy. They established additional hedges when the opportunity presented itself and they spent less cash without hurting production. Furthermore, the short-term outlook remains positive, as demonstrated by the company's post-Q2 payment. Unfortunately, this does not change the company's pessimistic long-term outlook, which still relies on the continued recovery of commodity prices.

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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.