By: Elliott Gue
Upstream MLP Legacy Reserves LP (NSDQ: LGCY) enjoyed a solid first quarter, growing production by about 5 percent sequentially, to 14,400 barrels of oil equivalent per day. Much of this uptick in production stemmed from elevated initial production rates on recently completed wells and a full quarter of output from $28 million in acreage acquired in November 2011. Improved takeaway capacity also bolstered natural gas output from the master limited partnership’s acreage in New Mexico.
Legacy Reserves in the first quarter realized an average of $70.51 per barrel of oil equivalent per day, compared to $68.10 per barrel of oil equivalent per day in the fourth quarter of 2011. The firm’s outsized exposure to oil and higher price realizations for this commodity offset a 14 percent decline in the price of natural gas and a 13 percent drop in the price of NGLs.
Higher production and average price realizations, coupled with management’s decision to limit capital expenditures in the first quarter, enabled Legacy Reserves to generate record-high DCF in the quarter and cover its distribution by 1.37 times. This coverage ratio is even more impressive when you consider that the MLP’s secondary offering in November 2011 increased the number of outstanding units.
The MLP’s conservative approach to calculating distributable cash flow–management doesn’t distinguish between capital expenditures for maintenance and those for growth–suggests that the publicly traded partnership should have no problem sustaining its distribution. Moreover, Legacy Reserves has hedged about 67 percent of its expected production in 2012, providing a buffer against the recent decline in oil prices.
Although management warned that second-quarter production would likely fall slightly short of the MLP’s output in the first three months of the year, the firm’s largest acquisition since December 2010 should prove accretive to cash flow in the third quarter.
The $88 million in acquisitions that the firm announced in the first quarter consisted of acreage in two distinct regions: the Rockies and Legacy Reserves’ traditional stronghold, the Permian Basin in west Texas.
The MLP paid $70.8 million to an undisclosed seller for oil-producing properties in Montana and North Dakota that have a current net output of 776 barrels of oil equivalent per day. All the acreage is proved, developed and producing, and management estimates the reserve life at about 11 years.
Not only does the deal diversify Legacy Reserves’ geographic footprint, but the acquisition also reflects the rising cost of acreage in the Permian Basin, the MLP’s traditional area of operations. CEO Cary Brown alluded to this challenge during a recent conference call to discuss first-quarter results:
One of the things that feels good is the Permian Basin right now is really hot and being able to buy in the Rockies because of the outstanding group we have up there and in some of these other basins really opens up the opportunities. As I’ve told guys around here, it’s nice to have multiple places to shop when you’re looking for acquisitions.
During the quarter, Legacy Reserves also announced $17.3 billion in bolt-on acquisitions, 74 percent of which are in Wyoming and 26 percent of which were in the Permian Basin. Management estimated production from these fields at 157 barrels of oil equivalent per day.
Finally, Cary and his team indicated that the MLP will drill its first horizontal wells in the Bone Springs and Yeso areas of the Permian Basin. Other operators in this vicinity have delivered impressive well results.
With plenty of opportunity to increase production in coming years and an oil-weighted production profile, Legacy Reserves is a solid bet to continue growing its distribution. Check out my MLPs report, for more picks.