Dig Into Nearly 35% YTM with Legacy Reserves, Bonds Mature December 2020

  • Production increased by 31% (year-over-year).
  • Revenue increase of 36% over the prior year period.
  • Adjusted EBITDA increased by 33% as compared to Q3 2017.

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 has recently made the successful transition from master limited partnership to C-corporation. In addition, the company posted another excellent quarter for Q3.

 

  • Production increased by 31% (year-over-year).

  • Revenue increase of 36% over the prior year period.

  • Adjusted EBITDA increased by 33% as compared to Q3 2017.

 Also in its third quarter, Legacy successfully converted $130 million of its outstanding notes into convertible notes (maturing in 2023), as well as had its borrowing base reaffirmed at $575 million. Recent volatility in the oil markets has seen oil prices decrease in Q4, but Legacy has survived far worse just a few short years ago. Durig Capital believes this volatility presents a buying opportunity for Legacy’s bonds, now trading at a significant discount, with a yield-to-maturity of about 35%. This discounted price and competitive yield make these bonds and ideal candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio.

 

Legacy Posts Third Quarter Results

 

Legacy Reserves’ most recent quarterly results were posted for the three months ending September 30, 2018. The company continues to show solid growth in production and revenues for both the three month and year-to-date periods. Some of the highlights from its most recent results include the following:
 

  • Legacy posted record quarterly oil production of 18.902 Bbls/d. This represents a 5.6% increase as compared to Q2 2018 and a whopping 31% increase as compared to Q3 2017.

  • Total revenues increased for both the third quarter as well as year-to-date. For Q3, revenues increased from $106.8 million in Q3 2017 to $145.2 million in Q3 2018, an increase of 36%. Year-to-date (as of September 30, 2018) revenues increased from $299.9 million in 2017 to $422.0 million in 2018, a massive increase of 41%.

  • Adjusted EBITDA also increased in the third quarter as well as year-to-date. For Q3, adjusted EBITDA increased by 33% to $78.4 million as compared to $58.7 million in Q3 2017. For the nine months ending September 30, 2018, adjusted EBITDA was $221.2 million as compared to $143.2 million for the same period in 2017, representing an increase of 54%.

     

In addition to these excellent results, Legacy had its fall re-determination of its revolving credit agreement. The company had its borrowing base successfully reaffirmed at $575 million.
 

About the Issuer
 

Headquartered in Midland Texas, Legacy Reserves Inc. is an independent energy company engaged in the development, production and acquisition of oil and natural gas properties in the United States.  Its current operations are focused on the horizontal development of unconventional plays in the Permian Basin and the cost-efficient management of shallow-decline oil and natural gas wells in the Permian Basin, East Texas, Rocky Mountain and Mid-Continent regions.  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.
 

Corporate Reorganization
 

In September, Legacy Reserves completed its previously announced transition from a master limited partnership into a C-corporation. Here is an overview of the transaction.

 

There are several benefits Legacy will realize as a result of this transition from partnership to corporation.

 

  • Allows entrance into the more supportive C-corporation sector: Legacy’s assets and growth development plan will be better served as a C-corp.

  • Enhances fiduciary duties benefiting shareholders: Directors and officers will now be subject to corporate fiduciary rules.

  • Allows the company to access lower cost of capital to fund future growth as well as improve its credit profile: This will allow the company to fund its growth efforts while addressing its credit profile.


Legacy recently proved its theory of greater access to capital markets as the company recently completed the conversion of $130 million of its outstanding notes to new convertible notes, maturing in 2023. This transaction provides a clear pathway for Legacy to lower its debt levels.  


Recent Volatility in Commodity Prices

 

Much of Wall Street is of the opinion that slowing economic growth and weakened demand is applying downward pressure on oil prices, driving the oil market deeper into bear territory. This sudden drop in prices has continued despite a pledge from the OPEC nations earlier this month to reduce its production by 1.2 million barrels per day. Adding to these concerns are the recent U.S. trade issues with China, a general economic slowdown in Europe as well as concerns around Brexit.  Another factor that is likely feeding oil’s volatility is continued surging production from the United States. Oil prices have now plunged by nearly 40% from their 52-week highs at the start of October. Last week, West Texas Intermediate (WTI) dropped by 11%, its worst weekly performance in almost three years.

 

However, many analysts see oil prices recovering in 2019, mainly due to supply and demand finally coming back into alignment. With the waivers for the Iran sanctions expiring in the first half of 2019, and OPEC’s production decreases starting in January 2019, analysts are predicting that oil will stabilize likely in the latter half of the year.
 

Interest Coverage and Liquidity
 

Interest coverage is of paramount importance as it indicates the company’s ability to service its existing debt. For it most recent quarter, Legacy had operating income of $61 million (without the effects of non-cash depreciation and impairment charges). Interest expense for the quarter was $29.4 million, resulting in an interest coverage of 2x. In terms of liquidity, as of September 30, 2018, Legacy had total liquidity of $48.5 million including cash and availability on the company’s credit revolver.

 

Risks

 

The risk for Legacy’s bondholders is whether Legacy can capitalize on its recent corporate reorganization as well as stay competitive within the recent oil price volatility. The company has already been able to convert some of its outstanding debt into convertible bonds, improving its debt profile by extending some of the maturities of its outstanding notes. As far as oil price volatility, the company has weathered much worse during 2015 and 2016 when oil prices hit decade lows. With new management coming on board in 2019 and with production continuing to increase, Legacy looks to be in a good position to withstand the current hiccup in oil prices. In light of these factors, the about 35% yield-to-maturity on the company’s 2020 bonds, does appear to outweigh the risks identified.

 

Legacy generates its revenues from the sale of oil and natural gas. While both oil and natural gas have experienced significant price volatility over the last few years, both have recovered from their lows of 2016.  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.

 

The recent boom of drillers in the Permian Basin (where Legacy is focused) has brought bottlenecks in getting all of the oil and gas being produced to market. Producers are pumping so much oil and gas that pipelines considered more than adequate just a few years ago now are overwhelmed. This has caused some of the region’s oil and gas to trade at significant discounts to benchmark prices. If this bottleneck persists, it could affect the price Legacy receives for a majority of the oil and gas it produces.

 

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 Reserves is no stranger to the struggles brought on by a volatile oil market. It masterfully rode through perhaps the most extreme oil downturn in recent history a few short years ago. The company continues to position itself for growth. Its recent reorganization from a master limited partnership to C-corporation should continue to pay dividends. It also continues to have success in its oil production, successfully using horizontal wells to consistently increase its year-over-year production. With new management ready to take the helm in 2019, the company has an opportunity to continue to increase revenue and profits while decreasing debt. Durig Capital already holds a position in Legacy’s bonds. The recent market jitters surrounding oil has created an excellent buying opportunity, and as such, these Legacy 2020 bonds are an ideal candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio.
 

Issuer: Legacy Reserves LP

Ticker: NASDAQ:LGCY

Coupon: 8.0%

Ratings: Caa3 / CC

Maturity: 12/01/2020

Pays:  Semi-annually

Price:  64.75

Yield to Maturity: ~35.0%

 

Disclosure: Durig Capital and certain clients may hold positions in Legacy’s 2020 bonds.

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.

Disclaimer: Please note that all yield and price indications are shown from the time of our research.  Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients.
 

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.


Disclaimer: The high yield strategies presented in this review by Durig Capital may not be suitable for all investors.  This is not investment advice from Durig Capital, nor a specific recommendation to buy or sell securities. If you have any questions or concerns about its suitability for your personal investment, you should seek specific investment advice from a registered professional before making an investment decision.

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