This Permian-Focused MLP Can Be a Healthy Addition to Your Portfolio

NEW YORK (TheStreet) -- Legacy Reserves (LGCY) is a Texas based small-cap MLP that is engaged in exploration and production from oil and gas properties located in the Permian Basin, Mid-Continent and Rocky Mountain regions. However, Legacy Reserves is essentially a Permian Basin-focused MLP. It has amassed a healthy liquids-rich portfolio on the back of a history of successful acquisitions. Over the last few years, the business has increased its liquid production and has reported reasonable growth of its revenues and income. Moreover, Legacy Reserves has rewarded its unit holders through consistent growth of cash distributions and a healthy dividend yield of 8.4%.

Its units are trading at 118 times its trailing earnings but Wall Street is expecting double-digit growth of its revenues in the next two years, which will be followed by earnings growth. Therefore, due to its growth prospects, attractive yield and growing cash distributions, this Permian-focused exploration and production MLP can be a healthy addition to your portfolio.

Low-Risk Acquisitions

Since 2006, Legacy Reserves has spent as much as its current market cap ($1.6 billion) on 119 acquisitions. The company now boasts an impressive 83.2 million barrels of reserves, which are weighted 68% toward oil and natural gas liquids.

Over the last few years, Legacy has spent an average of $200 million annually on acquisitions. Then in 2012, it spent a record level of $635 million, which includes a single purchase of $503 million at the Permian Basin. This year, Legacy has spent $100 million on acquiring properties through 11 transactions. Most of these have been fairly low-risk acquisitions as the company generally buys assets that are located around its existing acreage. By the end of 2012, Legacy's net developed and undeveloped acreage was 349,836 acres and 70,108 acres respectively.

What Is the Permian Basin?

The Permian Basin is at the heart of Legacy's overall operations. It is one of the oldest and largest oil and gas producing areas in the world. Last year, Occidental Petroleum (OXY) was the leading operator here in terms of oil production, followed by Pioneer Natural Resources (PXD) and Apache Corp. (APA).

Oil production from this region peaked out in the 1970s but following the arrival of new and sophisticated drilling techniques, like horizontal drilling and fracturing, the oil production started rising from 2008. Last year, the crude oil production from Permian stood at 312 million barrels, still below the production in the early 1990s, but 24% above the lowest levels of the mid-2000s.

The Permian Basin represents nearly 75% of Legacy's asset base. Legacy's primary acreage at Permian includes mature oil wells. Its current $90 million capital expenditure plan for 2013 is mainly focused on developing this region. Around 76% of Legacy's proven reserves are located in the Permian Basin.

Legacy's massive acquisition in this region was the biggest in its history and will provide significant long-term growth opportunities. The acquired properties contain estimated proven reserves of 25.6 million barrels of oil equivalents; which could hold 62% oil and 38% natural gas. Most of this acreage lies around counties where Legacy has existing operations, which makes it a fairly low-risk purchase.

Growing Top and Bottom Line

Amid these acquisitions, from 2010 till the end of the last fiscal year, Legacy recorded a 60% increase in revenues and a 40% increase in adjusted earnings to $346.4 million and $197 million, respectively. During this period, its oil, gas and NGL (natural gas liquids) production rose 43%, 13.3% and 100%, respectively.

The considerably greater increase in oil and NGL production, as compared to natural gas, points toward increasing focus on liquids due to the weakness in natural gas prices. The company's growth over the last couple of years can be attributed to its oil rich acquisitions, which caused an increase in liquids production. Overall, Legacy's average daily production rose 54% from 2010 to 14,811 barrels of oil equivalent per day in 2012.

So far, in the first nine months of the current year, Legacy has already surpassed last year's annual benchmarks. For the first nine months, the business has reported revenues of $363 million. The company's total oil production for the first nine months was also above its annual production in the 12 months ending December 2012. Similarly, Legacy's adjusted earnings for the first nine months of 2013 were $208.5 million, easily above the annual figure in 2012 mentioned earlier. For the first nine months, Legacy produced at an average of 19,755 barrels of oil equivalents per day.

Track Record of Cash Distributions

One of the key drivers of Legacy's growth is its reinvestment strategy. The company makes an acquisition, then reinvests around 20% to 30% of the cash flows to maintain the existing level of production and gives out the rest as cash distributions. This is how the company has grown and will continue to grow its cash distributions.

Legacy has a solid track record of cash-distribution growth. So far, the business has reported 12 consecutive increases in cash distribution. This includes the $0.585 per unit announced as quarterly distribution in the previous quarter, which shows a 3.5% year-over-year increase. Moreover, in its seven years of operations, Legacy has never reduced its distributions; not even during 2008-10 period that witnessed the global financial crisis and a significant decline in WTI prices.

Over the long term, Legacy will give healthy yields of around 8%, while increasing its cash distributions between 3% and 6% each year.

More Acquisitions

Since acquisitions underpin Legacy's growth strategy, therefore the business will maintain its average of investing $200 million on acquisition each year. There were no acquisitions in the previous quarter, despite the strong levels of liquidity, which increases the likelihood of an acquisition in the near future.

Currently, Legacy has a total liquidity of $418 million, a record for the company. By the end of September 2013, Legacy had more than $4 million cash reserves, $323 million drawn through revolver credit facility due in 2016, $300 million senior notes due in 2020 and $250 million senior notes due in 2021.

Increasing Production

Legacy has planned to considerably increase its output in the coming quarters. The company will direct most of its capital expenditure toward the Permian Basin, particularly at the Wolfberry and Bone Spring. Furthermore, Legacy could also start working with Pioneer to develop their acreage at the Wolfcamp, located in Martin County, in 2014. However, the management has pointed out that the total non-operating spending will remain within the 25% to 30% range.

However, due to its acquisitions focused growth strategy, the business has a debt-equity ratio of 136, which is considerably above the industry's average of 78.71. But the good thing is that Legacy has no short-term maturities. On the other hand, in terms of earnings, the debt is 2.8 times its EBITDA, which is reasonable for a growing E&P firm.

At the time of publication, the author had no positions in to stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Sarfaraz A. Khan is a capital market analyst and finance writer. Khan earned an MBA from the University of Aberdeen, located in the heart of the UK's oil and gas industry. Not surprisingly, his specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on Seeking Alpha, Motley Fool and TheStreet.

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