Legacy Reserves: Texas tea
Money no longer grows on trees. You have to mine it, drill for it, or plant, water and harvest it. As an independent oil and gas producer, Legacy Reserves L.P. (Nasdaq:LGCY) drills, and passes on a yield of 9% to investors.
As a master limited partnership — typically a low-risk, income-oriented investment — Legacy bases returns on cash distributions, which offer investors a relatively sound foundation for their portfolio. Although market conditions have conspired against nearly all investments, Legacy’s yield is as soothing as a glass of Texas tea. MLPs historically have little correlation to the S&P index and can have certain tax advatanges, making them an attractive choice when the market’s dicey.
Legacy, based in Midland, Texas, has properties mainly in the Permian Basin of West Texas and southeast New Mexico. It is rolling in black gold — oil, that is. The company’s proven reserves increased 71% to 32.1 million barrels of oil at the end of 2007, from 2006. Adjusted EBITDA increased 92% to $70.2 million, and revenues were $112.2 million, up from $59.8 million. Oil sales accounted for $83.3 million.
Legacy’s production in 2007 averaged 4,970 barrels of oil equivalent per day, up 63% from the previous year. In the fourth quarter, net oil, natural gas liquids, and natural gas production increased to 6,453 barrels of oil equivalent per day, up 24% from the third quarter. Legacy said the fourth quarter increase in production came from acquisitions, new wells drilled and completed, and from other projects finished in the third and fourth quarters of 2007.
And Legacy has added to its growing production, announcing its biggest acquisition ever on March 13. The company bought certain oil- and natural gas-producing properties located mainly in the Permian Basin at a cost of $82 million. The properties have estimated proven reserves of about 4.1 million barrels of oil equivalent. They are long-lived at 14 years, and 80% have already been developed. The acquisition will be immediately accretive to distributable cash flow and payable in the second quarter.
“Most importantly, this news gives us confidence that Legacy now feels comfortable with a broader array of deal flow, heralding even faster growth potential for cash flow and hence distributions,” said Raymond James analysts on March 14. They said the company also maintains significant cash flow flexibility to increase capital spending if it chooses.
The higher cost of capital now prevailing across the exploration and production MLP space “makes Legacy’s proven ability to seek out and close smaller, cheaper acquisitions (sub-$50 million) even more enticing than before,” said Raymond James. Still, Raymond James favorably views Legacy’s move into the realm of larger deals.
Raymond James raised its rating to “strong buy” from “outperform” after the acquisition news and the company’s fiscal 2007 results were released on March 13. “While recognizing that broader market dynamics have been systematically unfavorable for MLPs, we believe that the current entry point, with a yield of 9%, alongside a very strong M&A track record and 70%+ oil weighting, is too attractive to pass up,” the investment company said.
Including the acquisition, Raymond James’ estimate for 2008 distributable cash flow per unit is now $2.53; it rises to $2.78 in 2009, excluding other potential acquisitions. When Raymond James began coverage in February 2007, it estimated 2008 distributable cash flow at $1.56. The company’s target price is $28.
Legacy, which went public in January of last year, now has market capitalization of $588 million. It closed Wednesday at $19.82 per unit, at the low end of its 52-week range of $18.31 to $30.42. With a $1.82 payout, it is yielding 9%.
Every investment has risks, and here are some of Legacy’s: revenues, cash flow from operations and future growth depend substantially on factors such as economic, political and regulatory developments, and from competition of other energy sources. Oil and natural gas prices historically are volatile, although Legacy has hedged a significant portion of its expected production to mitigate that risk.
The company notes in its annual report that sustained periods of low prices for oil or natural gas could adversely affect its financial position, results of operations, access to capital, and quantities of oil and natural gas reserves that it can economically produce. Its acquisition strategy depends on its ability to get debt and equity financing, as well as locate and purchase attractive properties. Legacy’s current borrowing base of $225 million is scheduled to be reviewed by its bank group with any increase effective April 1, 2008.
Oils reserves dominate Legacy’s proven reserves, increasing the sensitivity of its assets value and revenues to changes in oil prices, notes Raymond James. Founding investors also own about 54% limited interest in Legacy and control the general partners, meaning their influence dominates major decisions.
Still, 9% income is home cooking. Right about now, Legacy’s (LGCY) vittles sound pretty good.
