Dismounting The White Elephant: Exiting Position In Vanguard Natural Resources Preferred B Shares

| About: Vanguard Natural (VNR)


In early March, I wrote an article describing why I purchased an 8% position in one of the VNR Preferred Series Units, VNRBP.

In the interim, oil prices have recovered substantially, up 40% from the day of publication of the earlier article, and fully 100% from the low on Feb. 11th.

Recovery in the oil price has supported higher prices for this speculative vehicle to the point where I can no longer recommend holding VNRBP and recommend a sale.

One should not necessarily infer that I expect VNRBP to go back down; however, I do not have the skill set needed to forecast future direction, thus the sale recommendation.

(Market values obtained from Yahoo Finance and Google Finance. VNRBP closed on March 11th, 2016 at $3.23/share and on Oct. 14th, 2016 at $5.00/share)

Introduction: On March 11th, 2016, I wrote an article (found here) entitled, "Revisiting the "White Elephant" Preferred Shares from Vanguard Natural Resources: Hold 'Em or Fold 'Em?". In turn, this article was prompted by an article authored by Vlae Kerschner entitled, "White Elephant: Inheriting a Busted Preferred" (found here) in which he had inherited one of the trio of VNR preferred share series. The security about which I wrote, VNRBP, is one of the three preferred share series of Vanguard Natural Resources (NYSE:VNR), the other two being VNRAP and VNRCP.

In response to Vlae's note, I wrote an article providing my analysis and viewpoint about VNR and VNR's preferred share series, using VNRBP as a specific example. In fact, VNRBP was the security that I purchased for my portfolio. I indicated that I was buying a "speculative" position which would represent about 10% or less of my portfolio; in fact, I believe that my position reached 8% at the highest point. One key point of the article was an analysis of the balance sheet, which showed that there were negative assets (and even more negative tangible assets) standing behind each preferred share or common unit. Therefore, one should not buy it to secure cheap assets as there were none. However, I also provided a "quasi-cash flow" analysis to show that VNR could keep it going, to wit:

Cash Items: Reported Earnings Items
Revenue $566,643
Reported Costs + $2,403,167
- Depreciation - $247,119
- Impairment - $1,842,317
- Goodwill Imp Loss - $71,425
Cash Costs - $242,306 + $242,306
Net Cash before Financing + $324,337
- Interest Expense - $87,573
Net Cash After Financing + $236,764

As you can see, it looked like there was enough cash being generated, in spite of the low prices of oil and gas, to keep VNR "in the game"; that is, there was enough cash flow to keep the interest current and keep VNR out of bankruptcy, given an interest coverage factor of 3.7. If VNR went into bankruptcy, the units and the preferred units would be toast, in my opinion, as there would be no assets to back them and creditors would receive all of the remaining assets, which might not even be enough to keep the creditors whole (again, means unit and preferred holders would get nothing). However, it appeared that VNR could keep the interest current to live to another day, hopefully with higher oil prices. If prices did recover, a spectacular recovery of full face value plus accrued interest (unfortunately, on which UBTI needed to be addressed in one's 2016 tax return) was possible and very large recoveries could be expected IF oil and gas prices also recovered.

At the time, oil was bottoming from one of the biggest short positions ever in oil trading. I purchased VNRBP as a "speculation", as I clearly indicated that there were no assets standing behind these units. The logic of the trade, even if I did not characterize it explicitly in this way, was that this was an inexpensive, highly levered play on recovery in the oil space.

My own purchase of VNRBP was actually made over weeks. However, the close of the day of publication was $3.23/share.

"Dismounting the White Elephant": Exiting the VNRBP Position:

I am exiting the VNRBP position. I have other, better needs for the cash and the security, to the extent that it will, has done what I think that it will. The market price for VNRBP was $5.00/share on the close of Friday, Oct. 14th, 2016, so the position will have increased by 55% in the intervening 7 months.

I have made the decision for several reasons:

a. Quite honestly, this was a fun speculation, but I now have better uses for the money. I have just written two articles on Navios Maritime Holdings (NYSE:NM) (into which I am moving some of these funds) and have written/am writing two more articles, one about an income investment and one an undervalued growth vehicle, where I would prefer to invest and, in fact, am redeploying money. Parenthetically, I had some RFT, related to another article, which I am also exiting to provide funds for new these new investments.

b. Oil has indeed increased (40% from the date of the earlier article and fully 100% from the low in mid-February) and the prices of VNR preferred share securities have responded. At this point, it becomes an issue of whether oil, having recovered from the low points earlier in the year, will continue to recover (or not). Oil hit a low of $26.19/barrel on Feb. 11th and had recovered to $37.77/barrel on March 11th, providing some confidence to make this purchase. It closed Friday at $53/barrel and determining whether it goes up or down from here is both important to know and requires a skill that is not in my core tool set.

c. I am not saying that VNRBP (or -AP or -CP) will not continue to be an attractive investment or that it will go to zero. I am saying that managing this investment is no longer connected to my core skill set and, as such, I am going to exit with a 55% gain.

d. Debt repayments will have been made by VNR and interest is continuing to be paid as well. However, as I continued to monitor cash flow, it appeared that there was not so much additional cash flow that one could see a "margin of safety" for all of the other requirements for cash that oil and gas producers have; indeed, some tough choices would need to be made to buy hedges or maintain/ream out existing/new wells. It did not look like there was enough money to do it all. Again, VNR may well continue to survive and get to a point where the preferreds are money good, but those assessments at this point of the cycle are not clear to me. "When it doubt, palms out" is very good advice and I am heeding it in this case.

e. I have already cleared out of my other "bet" on oil and gas price recovery made in February and March 2016. I had sold "in the money" puts against Anadarko Petroleum (NYSE:APC) in early March having a strike at 45 and expiration in January 2018 (when the stock was in the low $40s). For a while, the premium continued to increase, but APC turned around and moved higher (closed Friday at $63.37/share, 40% above the strike price). After a while, the premium began to reflect that price increase well above the strike and I covered the puts at about 1/2 of the value at which I sold them. As such, I have cleared my "oil and gas" investments and have no "oil and gas" positions in my risk account at this time. Other sectors now provide a better opportunity to do what I do.

Vlae, sorry to leave you like this, buddy, and I wish you the best in the future.

Disclaimer: No guarantees or representations are made. The Owl is not a registered investment advisor and does not provide specific investment advice. You should always consult with an investment advisor before buying or selling securities.

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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