Is QR Energy LP's 11% Yield Worth the Risk?

QR Energy Partners (NYSE: QRE) is an upstream master limited partnership, or MLP. Like most upstream MLPs, QR Energy Partners is interested in mature acreage with shallow decline rates and high margins. Also, like most upstream MLPs, QR energy is interested primarily in returning its cash proceeds to shareholders.

Of the largest upstream MLPs, QR Energy is among the highest yielders. At over 11%, QR Energy's yield outstrips that of Linn Energy and BreitBurn, both of which offer about 10% yields at this time. But as any cautious investor knows, it's not always worth chasing a higher yield. This article will take a look at QR Energy's value proposition. Recently, units of QR tumbled by over 5%. This article will look at why the unit price dropped, and whether units are worth picking up here. 

QR Energy Investor Relations

Asset base
First a quick look at the partnership's assets. Over 40% of production comes from the "Ark-La-Tex" region. Another 30% comes from the Permian. QR Energy is an oily partnership, too. Over 61% of the partnership's production is oil. The partnership's focus on oil gives it a per-barrel EBITDA margin considerably higher than that of its peers. For each barrel equivalent produced, QR Energy keeps over $42 in EBITDA margin, whereas the peer average is in the low 30s. 

Why units dropped by 5%
Units dropped by 5% for a fairly straightforward reason: Management elected to change its capital strategy this year. Specifically, the partnership will be shifting focus from acquisitions to organic growth, and will look to exploit its fairly deep drilling inventory, mostly in the Permian. This spooked Wall Street because an increased drilling budget will likely mean a big hike in capital spending, for which we may not see substantial benefits until 2015 or at least the later part of this year.

As it is, QR Energy's distributable cash flow, or DCF, was only 1.0 times the distribution itself, with no full-year DCF guidance typically provided. There isn't much room for error here. 

Compounding that problem is QR Energy's riskier balance sheet. While most upstream MLPs like to keep debt at between 2 and 3 times EBITDA, QR Energy's debt sits at around 4 times trailing twelve month EBITDA, and that number rises to 5 times when preferred equity is factored in. Compare that with a more conservative peer such as Vanguard Natural Resources (NASDAQ: VNR), whose debt typically sits at around 3 times EBITDA, and you can see why investors are putting QR Energy in the discount bin. Also worth noting is that the partnership's revolving credit line is currently the largest piece of the partnership's debt.

The significance of higher debt is the following: If rates were to significantly jump and stay high, QR Energy will have more trouble refinancing and maintaining its distribution than will other upstream MLPs. With interest rates at historic lows, rate increases are only a question of 'when.'

An oilfield outside of Andrews, TX, in the Permian Basin. Source: Wikipedia

Bottom line
QR Energy is one of those cases where a security is discounted for a reason. Looking at the big picture, QR Energy's plan to focus on organic growth could be the right choice. After all, the acquisition market for mature, long-lived oil and gas properties is becoming increasingly competitive. Perhaps QR Energy's inward turn, then, will end up being a wise, contrarian move.

However, the partnership's relatively high debt and lack of forward guidance are good reasons to look for less risky options within the already risky space of upstream MLPs. Vanguard Natural Resources, for example, has a more reasonable debt level and also provides forward guidance. While Vanguard may have a lower yield of just 8.3%, it would be a less risky choice here. 

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