For many income investors, master limited partnerships continue to be a top draw, as many various firms across energy industry have used the corporate structure to avoid taxation — a move that results in high distributions for unit holders as well as the sponsoring general partners.
One of the more interesting ways to play MLPs has been in the upstream subsector … and Linn Energy (NASDAQ:LINE) — along with its c-corp subsidiary LinnCo (NASDAQ:LNCO) — has been leading the way.
For that very reason, upstream MLP Vanguard Natural Resources (NYSE:VNR) could also be a great addition to any portfolio, as it seems to be copying Linn’s every move with equal success … while remaining relatively ignored by the mainstream.
See, like many other upstream MLPs, Vanguard focuses on developed acreage with mature production profiles. Since MLP tax structure requires firms to pay the bulk of their earnings back to shareholders and doesn’t allow for a “rainy day fund,” these properties need to provide a high percentage of proven developed reserves, have long reserve life and have a possibility of step-out development for additional growth.
Currently, VNR operates various fields across the country including some big acreage in Permian Basin and has reserves of over 189 million barrels of oil equivalent. The real kicker, though, is how it’s been growing those reserves.
Like Linn, Vanguard has been an acquisition hound. Since going public, the upstream firm has completed 17 strategic acquisitions that increased its reserves by over 1,282%. However, while many firms have been buying or adding liquids rich — i.e. shale oil — fields, Vanguard has taken the contrarian approach and has sprinted into natural gas production.
In 2012, VNR spent over $760 million for assets from Antero Resources and Bill Barrett Corp. (NYSE:BBG), giving it production in the Arkoma, Piceance, Wind and Powder River basins. More recently, it cut a deal with Marcellus shale-focused Range Resources (NYSE:RRC) to buy $275 million producing assets in the Permian Basin. These moves bumped Vanguard’s natural gas output to about 65% of total production.
While it may seem crazy to be buying natural gas assets at a time when prices for the fuel are still near historic lows, Vanguard’s strategy makes sense.
First, given the low-price environment, many firms are selling these assets at rock-bottom prices just to get rid of them. Those low purchase prices means VNR is able to generate a return at much lower natural gas prices. According to its latest quarterly results, lease operating expenses for Vanguard dropped from $17 per BOE in the fourth quarter 2011 to roughly $9 per BOE by the end of 2012.
Secondly — like Linn Energy — Vanguard has an active hedging policy. The firm has about 80% of its expected natural gas production hedged through the first half of 2017 at an average floor price of $4.73 per MMBtu. This, combined with lower lease expenses, makes a powerful profit combo that leads to great cash flows and distributions.
Plus, those dividends could be getting even juicier as management has nodded to the possibility of more deals in 2013.
Since it has been on tear lately with its natural gas buys, many analysts have speculated — and VNR management has hinted at — forming a C corporation spin-off similar to LinnCo. That spin-off has allowed Linn Energy to attract tons of capital from both institutional and retail investors in order to pursue more deals. Despite its smaller size, there’s no reason why Vanguard couldn’t create ‘VNCO’ to take advantage of the opportunities.
Like top-dog Linn, Vanguard Natural Resources seems to be making all the right moves to increase value. Already management has shown that it knows how to get deals done and reward shareholders. Since its IPO, VNR has produced dividend growth of 43%. Currently, that dividend sits at 20.3 cents per share paid monthly.
That works out to be a hefty 8.5% dividend yield.
The company’s focus on natural gas is certainly a unique approach given the switch to liquids production over the last year or so. However, that focus on dry gas could pay off in the long term as demand for fuel — both here and abroad — continues to grow. In the meantime, the firm’s distribution will help the wait go by faster.
Personally, I’m going to wait for ‘VNCO’ … but that doesn’t mean you have to. VNR is still a serious portfolio contender.
As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.