Why Vanguard Natural Resources, LLC Sank 48.6% in 2014

By Markets Fool.com

Vanguard Natural Resources, LLC investors likely want to forget about 2014. Oil prices rolled over in the second half of the year, and took Vanguard Natural Resources down with it.

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VNR Chart

VNR data by YCharts

As we see in that chart, the price of oil fell nearly 44% in 2014, which is a little less than the plunge taken by Vanguard Natural Resources' units. However, what's interesting about this correlation is the fact that for all intents and purposes Vanguard Natural Resources is a natural gas company. Because of this it appears like Vanguard Natural Resources might have been unjustly punished last year. That said, it could have avoided this punishment all together if weakness wasn't exposed in what was supposed to be an area of strength.

Turning on the gas
For what its worth, Vanguard Natural Resources was no where near as bullish on oil as most of its peers. As the following slide shows, the company shifted its focus to natural gas over the past few years so that now more than two-thirds of its reserves are natural gas.

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Source: Vanguard Natural Resources Investor Presentation.

As the company notes on that slide it chose to focus on natural gas because the natural gas assets that were available for sale offered a better value than oil assets. By focusing on value the company avoided buying oil assets at what turned out to be the top of the market. That being said, it is still being punished along with its peers as it's being lumped in the same basket.

Weakness exposed
Some of that punishment is justified as the company's hedges are weaker than they could have been. As the following slide shows, the company does have most of its oil and gas production hedged in 2015.

Sources Vanguard Natural Resources Investor Presentation.

Normally, these hedges would provide more than enough protection for the company. However, these aren't normal times as oil prices continue to fall, which will cut into the company's oil cash flows in 2015 if the current price persists. This will weaken the company's distribution coverage ratio as it really needed $90 oil and $3 natural gas to be able to maintain its distribution for the full-year. With the price of oil now half that amount, and natural gas prices heading closer to the $3 mark, it's putting the company's distribution on shaky ground.

Investors really think that Vanguard's distribution will be cut. As its unit price has cratered its yield has skyrocketed well past its historical high as we see in the following chart.

VNR Chart

VNR data by YCharts

Investors view the yield as being unsustainable at its current rate, which is why units have sold off so deeply. Investors are basically pricing in a 50% reduction in the distirubtion, which makes sense given that we've already seen two of the company's top peers slash their distribution in half to start 2015. Those cuts have actually encouraged Vanguard to follow suit, though at this time the company hasn't made a distribution cut announcement. That being said, the company's CFO Richard Robert told the Wall Street Journal that its peers are, "doing something drastic now in order to fight another day,"which is a move he called "prudent." He further noted that a distribution cut might "ultimately be the prudent thing for us to do, at least you sleep a little better at night."

Investor takeaway
Vanguard Natural Resources thought that its move away from oil would pay off down the road as it was a long-term bet on natural gas. Unfortunately, before that bet could pay off the price of oil collapsed, taking Vanguard down with it as it didn't have enough hedges in place to protect against this possible outcome. Because of that it's becoming more likely by the day that the company will slash its distribution in early 2015 so it too can live to see the day that its bullish bet on gas pays off.

The article Why Vanguard Natural Resources, LLC Sank 48.6% in 2014 originally appeared on Fool.com.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.