This week, Durig Capital takes an updated look at an oil and gas producer whose focus is primarily in the Permian Basin in Texas. Legacy Reserves recently released some outstanding results for its fourth quarter and full year 2017. (Durig Capital has reviewed Legacy Reserves four times -
July 2016,
December 2016,
June 2017 and most recently in
November 2017).
- Q4 revenues increased by 50% year-over-year.
- Legacy had record production in Q4 as well as for full-year 2017.
- 2017 Adjusted EBITDA increased 45% over 2016 levels.
- Interest coverage of 2x for 2017.
Legacy continues to produce consistent results, even beating analyst’s revenue projections in its latest quarterly results. After posting fantastic results for each quarter in 2017, Legacy has projected healthy increases in both production and adjusted EBITDA guidance for 2018. The company’s 2020 bonds, couponed at 8% and currently priced around 80, offers a yield-to-maturity over 17%. This excellent yield makes these bonds are an ideal candidate for additional weighting in our
Fixed Income 2 (FX2) portfolio as well as our
Distressed Debt 1 hedge fund. The most recent aggregated benchmarked performance of the FX2 portfolio is displayed below.
Legacy Posts Fantastic Fourth Quarter and Full-Year Results
Legacy Reserves posted its results for Q4 and FY 2017 this past week. Legacy’s fourth quarter revenues surprised analysts, exceeding estimates by $7.13 million. However, the revenue surprise is just the beginning of what looks to be a breakout quarter and year of redemption for this oil and gas producer.
- Legacy had record production in Q4 of 49,185 Boe/d, representing a 7% increase over Q3 production. The company also posted record production for full year 2017 of 44,967 Boe/d.
- Q4 revenues were $137.1 million as compared to $91.6 million in Q4 2016, a 50% increase year-over-year. Full year 2017 revenues increased by 38.8% over 2016 levels, growing to $436.3 million.
- For full year 2017, Legacy posted an astounding 45% increase in adjusted EBITDA, increasing to $226.2 million.
As mentioned in Durig’s last review of Legacy, adjusted EBITDA continues to show consistent growth, both year-over-year as well as consecutive quarterly growth. Legacy’s Q4 performance definitely builds on the positive momentum forged in the first nine months of 2017.
About the Issuer
Legacy Reserves LP is a master limited partnership headquartered in Midland, Texas, focused on the acquisition and development of oil and natural gas properties primarily located in the Permian Basin, Mid-Continent and Rocky Mountain regions of the United States. Its primary business objective is to generate stable cash flows from the acquisition and development of long-lived oil and natural gas properties, allowing the company to support and increase quarterly cash distributions over time. Since 2006, Legacy has made 137 acquisitions of producing properties for approximately $2.6 billion. In its efforts to generate stable cash flows and reduce its commodity price risk, the company has an active oil and natural gas hedging program.
Credit Statistics Improving, Update on Debt Transactions
One of Legacy’s goals in 2017 was to improve its credit metrics. Thanks to increased production and revenues, along with prudent management of its operating and capital budgets, Legacy was able to reduce its total debt / EBITDA by 2.1x. In addition to this good news, the company recently announced a few updates on its outstanding debt. First, the company was able to increase and extend the terms of its 2nd Lien Term Loan with GSO Capital Partners. This Term Loan was originally set to come due in October 2018. With the recent increase and extension, this loan increased from $300 million to $400 million and now comes due in October 2019. In conjunction with this transaction, Legacy also repurchased $187 million of its 6.625% 2021 notes for a price of approximately $131 million.
Diverse Revenues from Oil, Natural Gas
Legacy Reserves is probably most recognized as an oil company. However, the last few years have seen more than half of the company’s revenues generated by the sale of natural gas and natural gas liquids. The following table illustrates the increasing role of natural gas / NGLs on Legacy’s revenues.
While the price of natural gas has not appreciated as quickly as the price of oil over the past few months, it is still a valuable and essential commodity for today’s economy.
Looking Ahead
Legacy’s management is forecasting significant growth in 2018. In the company’s last earnings release, management estimated that 2018 adjusted EBITDA would range between $300 million and $360 million. At the midpoint of this guidance ($330 million), this would represent a 46% increase over 2017’s adjusted EBITDA. In terms of production, Legacy is projecting between 47,875 Boe/d to 52,808 Boe/d. The midpoint of this guidance would represent an increase over 2017 levels of approximately 12%.
The other item that was discussed in Legacy’s most recent earnings press release and conference call was the company’s current evaluation of “alternatives to change our legal and tax status”. When questioned about this issue on the most recent earnings call, Dan Westcott declined to expand on the possibilities although he did acknowledge that any such move would require a unitholder vote. Exactly what this means for investors has yet to be determined.
Interest Coverage
Interest coverage is of primary importance for bondholders as it indicates the company’s ability to cover the interest on its outstanding debt. For 2017, Legacy Reserves had operating income of $182.3 million (when removing the non-cash charges of impairment and depreciation /amortization etc.) and interest expense of $89.2 million. This results in an interest coverage ratio of 2x, quite remarkable, especially considering the excellent 17.1% yield-to-maturity on Legacy’s 2020 bonds.
Risks
The risk for bondholders specifically is whether Legacy can continue on the trajectory it has established in 2017 and carry this forward through 2018 and 2019. The company consistently grew adjusted EBITDA each quarter of 2017 along with registering record annual production for the full year. According to the Legacy’s guidance for 2018, this momentum should continue, with a 46% increase in adjusted EBITDA (midpoint) and a 12% increase in overall production (also at midpoint). The company has been able to extend the due date of its 2nd Lien Term Loan to October 2019. If oil prices continue to remain stable and Legacy is able to execute on its planned guidance and successfully address its debt maturities in the next few years, Legacy appears to be on the path to long-term growth.
Legacy generates its revenues from the sale of oil and natural gas. While both oil and natural gas have experienced significant price volatility in the last few years, both appear to be making a recovery, especially the recent price of WTI. However, if prices of oil and natural gas were to return to the low levels seen in the past three years, this would definitely have an adverse affect on Legacy’s ability to meet its ongoing operating expenses as well as debt interest.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Legacy had a fantastic 2017, recording record production and a significant increase in revenues over 2016 levels. The company has improved its credit metrics and extended a key debt maturity. Legacy has also projected significant increases in production and adjusted EBITDA for 2018. With the price of oil and natural gas stabilizing over the past few months, it appears as if Legacy is in an ideal position to significantly increase its revenues and profitability. The company’s 2020 bonds, couponed at 8% and currently priced with a yield-to-maturity of over 17%, are ideal for additional weighting in both our
FX2, high-yielding fixed income portfolio as well as our
Distressed Debt 1 Hedge Fund. The most recent tear sheet of
Distressed Debt 1 is shown above.
Issuer: Legacy Reserves LP
Ticker: (NASDAQ:LGCY)
Coupon: 8.0%
Ratings: Caa3 / CC
Maturity: 12/01/2020
Pays: Semi-annually
Price: 80.650
Yield to Maturity: ~17.15%
About
Durig Capital
Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services.
Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured, or at Interactive Brokers. We have now started offering our highly successful FX2 service to clients of other Registered Investment Advisors through segregated accounts at TD Ameritrade. Please ask us to learn how this might work for you and your current advisor.
We track thousands of bond issues and their underlying fundamentals for months, sometimes years, before finding any that achieve or surpass the targeted criteria we have found to be successful. Our main priority is to provide the best opportunities for our clients. Our bond reviews are first distributed to our clients, then published on our website and our free email newsletter, and lastly on the Internet and distributed to thousands of prospective clients and competitive firms. Bond selections may not be published if they have very limited availability or liquidity, or viewed as not being in the best interests of our clients. When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services.
Disclosure: Durig Capital and certain clients may hold positions in Legacy Reserves LP 2020 bonds.
