Saturday, February 22, 2014

This 11% Yield MLP Is Still Not an Attractive Investment

This article was originally published by TheStreet
By Sarfaraz A. Khan February 22, 2014
NEW YORK (TheStreet) -- LRR Energy (LRE_) is a small-cap upstream limited partnership, formed by Lime Rock Management in late 2011. It acquires and develops oil and natural gas properties in North America. The business, which gives an attractive yield of more than 11%, has properties at the Permian Basin, the Mid-Continent region and the Gulf Coast, with more than 30 million barrels of proven reserves.
LRR's shares are trading at around $17, which is 32 times its trailing earnings and 4.7 times its trailing sales.
LRR has a lot of promise. The firm offers attractive dividends and has the potential for long term growth from the Permian Basin, particularly from Red Lake fields. The business has spent nearly all of its capital expenditure on its oil-weighted acreage and therefore will likely increase its oil output for 2014. Moreover, the business can also grow its reserve base due to more drop-downs from its predecessor, Lime Rock Resources.
On the other hand, LRR Energy has little to show in terms of execution. Investors would normally expect double digit growth from a newly established small-cap upstream MLP. But for LRR, so far, there has been no meaningful growth in terms of revenue, income or production. Its fuel sales have increased by just 2% from last year, while its adjusted earnings have dropped in the corresponding period.
For these reasons, and despite the above-average yield, I believe that investors should adopt a wait-and-see approach. LRR Energy could become an investment option when the business shows clear signs of improvement, particularly in terms of higher oil production.
LRR Energy has recently increased its quarterly cash distribution to $0.4875 per outstanding unit. This was the fifth consecutive quarterly increase, which translates into a yield of 11.45%.
There is no shortage of MLPs operating at the Permian Basin. Some are much bigger and better-established than LRR Energy, like Legacy Reserves (LGCY_), or EV Energy Partners(EVEP_). But there are very few firms that offer yield of more than 11%. QR Energy (QRE_) is one of the few other MLPs with exposure to the Permian Basin and with a yield of more than 11%.
During a recent energy conference in December, LRR Energy revealed that it has amassed 31.7 million barrels of oil equivalent as reserves. Of these, nearly 54%, or 17 million barrels, are located at the Permian Basin. These reserves are 71% liquid and have a proven reserve life of 13.1 years.
Outside the Permian Basin, LRR's other reserves at the Mid-Continent and Gulf Coast are more than 70% natural gas. The MLP gets nearly 29% of its average daily production from the Mid-Continent and nearly 17% from the Gulf Coast. Overall, LRR Energy's total reserves are 50% liquid and have a reserve life of 13.2 years.
At the Permian Basin, LRR's focus has been on the development of its oil-weighted properties at Red Lake. While its total Permian Basin acreage, including its properties at Pecos Slope and Corral Canyon, is 55% oil, the Red lake field is 62% oil.
For 2013, LRR Energy has allocated $28.1 million -- more than 80% of its total 2013 capital budget of $34 million -- to this field. So far, LRR Energy has drilled 23 wells and has recompleted 21 wells at the Red Lake field. Through its focus on this oil-weighted acreage, LRR should be able to increase its oil output in the coming years.
Moreover, although the business has not announced the details of its 2014 capital expenditure, the management has stated that the new budget will be in-line with last year's expenditure. The budget, as in 2013, is going to focus on the development of the oil-weighted properties. The official announcement should come within a few weeks. It is clear that LRR Energy is targeting an increase in its oil production in the coming years.
LRR Energy has grown based on acquisitions and drop downs from its predecessor, Lime Rock Resources and its related funds. Since its IPO, LRR has done three drop-down deals valued at $125 million. Lime Rock still has around 30 million barrels of reserves, which could become potential drop-downs in the future. Most of these reserves are oil-weighted and could become an attractive addition to LRR's portfolio.
Moreover, Lime Rock Resources has also recently created a new $750 million fund to acquire oil and gas properties worth $1.5 billion. In the long term, these properties could also become drop-down candidates for LRR.
Investors should note that although the acquisition and drop-down environment has been active, the pricing environment isn't favorable right now. This means that despite the uptick in activity, there is little chance of a major acquisition in the near future.
On the other hand, the company's performance in 2013 has not been impressive. In the first nine months of its operations in 2013, LRR has reported no meaningful increase in production. Its adjusted earnings before interest, taxes, depreciation and amortization have dropped by 5.7% from last year to $59.12 million. This raises questions over the firm's ability to grow its top-line and production levels.
LRR Energy has now narrowed its full year production guidance from the previous range of 6,300 to 6,550 barrels per day to 6,400 to 6,500 barrels per day.
This means that even at the high end of its updated guidance, the business would show a slight improvement (+3.1%) from average net production in 2012. Moreover, even if LRR manages to hit the high end of its guidance, then its average daily production would still be low compared to the average net production of 6,543 barrels per day in its few weeks of operations as a partnership in 2011.