Vanguard Natural Resources: Despite Restructuring, Debt Remains An Issue

Summary

• Despite restructuring, Vanguard still has a high amount of debt.
• It also has a substantial amount of negative value hedges.
• Combined with low natural gas prices, Vanguard is in danger of violating its credit facility debt to EBITDA convenant.
• Vanguard is likely to sell a number of assets in an attempt to alleviate its covenant issue.

Vanguard Natural Resources (OTCQX:VNRR)(NYSE:VNR) is still struggling with its a high level of debt despite exiting restructuring in 2017. Many oil and gas companies that have restructured have been able to shed most of their debt, but due to Vanguard's large proportion of credit facility debt, it still has over $900 million in debt remaining. This is around half of its debt level when it restructured, but its production is also down around 15% since then.

This has led Vanguard to look at selling assets, which appears necessary to deal with its credit facility debt covenant. The combination of negative value hedges and relatively weak natural gas prices will likely result in that debt to EBITDA covenant being violated by late 2018 without future asset sales.

Vanguard's Hedges

Vanguard has a significant amount of hedges, with around 72% of its estimated 2018 natural gas production hedged, along with 85% of its estimated 2018 oil production and around 42% of its estimated 2018 NGL production.

The problem for Vanguard is that its hedged prices are generally pretty low. It has oil hedged at $46.59 for 2018 and some NGL components hedged well below current strip prices as well. Vanguard's natural gas hedges are at $3.00 for 2018, so those have positive value, but overall, Vanguard's hedges are expected to provide around negative $43 million in value during 2018.

Vanguard's hedges are at fairly low prices in future years as well, although the negative value may not be as much due to the smaller amount of hedges and expectations for weaker oil and gas prices (as indicated by the futures curve).

Source: Vanguard Natural Resources

Vanguard's 2018 Outlook

The midpoint of Vanguard's production guidance is 372,500 Mcfe per day. At that level of production and $62 NYMEX oil and $2.85 NYMEX natural gas (around current 2018 strip prices), it would deliver around $438 million in oil and gas revenue. Vanguard's hedges have around negative $43 million in value, so total revenues would be approximately $395 million net of hedges.

Type	Units	$/Unit	$ Million
Oil [Bbls]	3,175,500	$55.75	$177
Natural Gas [Mcf]	97,637,500	$1.85	$181
NGLs	3,212,000	$24.80	$80
Hedge Value			-$43
Total			$395

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With $160 million in capital expenditures, Vanguard is expected to have around $449 million in total cash expenditures. This leads to an estimate of $54 million in cash burn during the year.

Type	$ Million
Lease Operating Expenses	$143
Production Taxes	$44
Cash G&A	$43
Cash Interest	$59
CapEx	$160
Total	$449

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Vanguard's G&A expenses include $3.4 million in post-emergence restructuring costs. Without hedges and those one-time costs, Vanguard would approach neutral cash flow (around negative $8 million in cash flow).

Vanguard's guidance implies that its 2018 average production will be around 4% to 5% higher than Q4 2017 levels. Its Q4 2018 production is probably going to be around 7% higher than Q4 2017, although that growth is likely mostly from natural gas.

Vanguard's break-even point looks pretty close to future strip prices, so it is uncertain whether it can grow production while spending within cash flow, even without negative value hedges.

Vanguard's Future

Vanguard's credit facility has a covenant requiring first-lien debt to trailing four-quarter EBITDA to be no more than 4.75x starting in Q3 2018. This could be an issue for Vanguard as current strip prices indicate that its 2018 EBITDA may end up at around $165 million after hedges. This would support first-lien debt of $784 million, while Vanguard had $825 million in first-lien debt at the end of 2017 and is forecast to burn cash during the year.

To address its debt issue, Vanguard is marketing some of its assets, but it may need to continue selling assets going forward. The debt to EBITDA covenant goes down to 4.5x in 2019 and 4.25x in 2020, while oil and gas futures prices are weaker going forward.

While there is probably not much point in Vanguard restructuring again since most of its debt is first-lien debt, there appears to be a significant chance that Vanguard will need to sell a substantial amount of assets to escape its credit facility issues.

Vanguard's reserves had a PV-10 of $1.195 billion at the end of 2017 based on SEC pricing, compared to $912 million in debt principal, so there is some hope that there will be decent value left for the shareholders after some asset sales.

Conclusion

Despite restructuring, Vanguard still has a significant debt problem. With weak natural gas prices and negative value hedges, it has a good chance of violating the credit facility's first-lien debt to EBITDA covenant by late 2018. Thus Vanguard is likely going to be selling a fair number of assets to attempt to reduce its first-lien debt.

Shareholder value will depend on what value Vanguard can get from its asset sales. With Vanguard's reserves having a PV-10 greater than its current enterprise value, there is a decent chance that shareholders will do okay, but it is a risky proposition.

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