Vanguard Natural Resources LLC (VNR) will tackle the integration of Encore Energy Partners in 2012. Following the divestment of the oil and gas producer's Appalachian assets -- a deal that essentially canceled units held by co-founder investor Majeed S. Nami -- Encore Energy Partners' acreage accounts for roughly 52 percent of the combined firm's total reserves. The acquired assets are heavily weighted toward oil and NGLs, and I expect the new owner to extract substantial value from this acreage.
The deal closed in December, which means that management's comments on the LLC's fourth-quarter performance offered little guidance on how the integration will proceed. However, the addition of these reserves should boost the combined company's production and average price realizations.
During the fourth quarter, Vanguard Natural Resources' distributable cash flow surged by 120 percent from year-ago levels and 95 percent sequentially, enabling the LLC to cover its quarterly payout by a 1.4-to-1 margin. With cash flow likely to grow significantly in the coming year, I expect management to approve additional distribution increases in 2012.
Fourth-quarter production soared to 13,405 barrels of oil equivalent per day, with liquids output surging to 85 percent of overall revenue-up dramatically from 52 percent in 2009. The addition of Encore Energy Partners' assets also expands Vanguard Natural Resources' liquids-focused drilling inventory and the potential for bolt-on-acquisitions in adjacent acreage.
Vanguard Natural Resources has also established a sizable position in the Williston Basin, home to the Bakken Shale and considerable amounts of light oil.
Even after closing the acquisition of Encore Energy Partners, the LLC is still relatively small and could be a potential takeover candidate.
The stock price is up 4.9 percent on the year, lagging several peers. Some if this underperformance likely reflects integration risks, while some investors have failed to factor in the firm's shifting production mix and overestimate the LLC's exposure to depressed natural gas prices.
Management expects the company's liquids output to increase by 12 percent in 2012, though reduced drilling activity in dry-gas plays will lead to flat overall production A solid hedge book means that the firm's exposure to natural gas isn't much of a concern.
At the same time, the management team has indicated that it would consider a deal to increase its exposure to natural gas, provided that the valuation offered attractive returns.
The big question hanging over the stock: Whether Vanguard Natural Resources will be able to grow production from Encore Energy Partners' acreage, especially after the MLP's former general partner Denbury Resources (DNR) opted to slash investment in these properties.
With the disposal of the firm's Appalachian acreage, the answer to this question will have a profound effect on Vanguard Natural Resources' profitability and stock price.
With a distribution yield of 8.3 percent, the stock appears to price in this risk.