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A Double-Digit Yield Isn’t Everything

April 19, 2014 | About:

Linn Energy (LINE) has faced several analyst downgrades following the release of its quarterly results and annual guidance. The company is eying more than 30% growth in 2014, but in terms of production-per-unit, its output will decline. Moreover, the company has also targeted a tight distribution coverage ratio of 1.00x.

As a result, the units of Linn Energy, and its affiliate LinnCo (LNCO) have struggled; both have fallen by more than 10% since the day of the earnings release. However, an asset deal related to its Midland acreage could result in an upside. Moreover, the company, which is one of the largest upstream master limited partnerships in terms of enterprise value, gives a juicy double-digit yield.

For these reasons, although Linn Energy looks attractive for dividend hunters, others might consider looking into Linn’s peers with better near term growth prospects and a higher coverage ratio.

Quarterly Results

In the previous quarter Linn Energy increased its production by 11% from last year to 889 million cubic feet equivalents per day, or MMcfe/d, with Berry Petroleum contributing 44 MMcfe/d. Excluding the positive impact of Berry Petroleum, Linn Energy could only manage to grow its production by 5.5%.

The company’s sale of natural gas and NGL rose 27% to $585 million while total revenues increased by 10.1% to $629 million. On the other hand, its net loss widened to $785 million, or $3.15 per unit, an increase from a net loss of $187 million in the corresponding quarter last year. This was driven by massive non-cash impairment charges of $3.19 per unit and as well as lower derivative gains as compared to last year’s results.

Analysts were expecting earnings of $0.27 per share from revenues of $627.29 million.

For the full year, Linn Energy’s production increased by 23% to 822 MMcfe/d, including 11 MMcfe/d from Berry Petroleum. Sales climbed 29% to $2.1 billion while the company widened its net loss from $387 million in 2012 to $691 million in 2013. This increase in loss was also driven by higher impairment charges.

Nominal Increase In Production

For 2014, Linn has forecast production of between 1,070 MMcfe/d and 1,140 MMcfe/d, a growth of between 30.1% and 38.6% from last year. Although this is significant, Linn’s unit count has grown by 40% from last year due to Berry Petroleum’s acquisition, the company’s production per unit will decline. In other words, the production growth will be nominal as production per unit, which is a better yardstick for measuring an E&P company’s performance, will decline.

34% Growth In Reserves

In 2013, Linn Energy acquired Berry Petroleum, valued at $4.6 billion, with nearly 1.4 trillion cubic feet of reserves. Moreover, Linn Energy has also purchased oil and gas properties in the Permian Basin for $528 million with 175 billion cubic feet of proven reserves.

Following the acquisitions, Linn Energy’s reserves now stand at 6.4 trillion cubic feet equivalents, a 34% improvement from 2012. Most of its reserves, 47%, are natural gas, while 34% are oil and 19% are NGLs.

Although Linn has grown its reserve base, but then again, in terms of reserves per unit, there hasn’t been any meaningful increase.

Asset Deal

At Permian Basin, Linn Energy owns more than 160,000 net acres at Central Basin, Delaware Basin and (as discussed above) Midland Basin. The area has nearly 160 million barrels of oil equivalents of proven reserves, of which 80% are liquids.

However, the problem with some of Linn Energy’s Permian assets is that they are expensive to develop due to horizontal drilling requirements, which is also outside of the scope of Linn Energy’s core operations. Moreover, the new wells from this region, like most of the other new wells, will have above average decline rates which could further create problems for the company.

As a result, the Linn Energy has highlighted in a recent presentation that it could sell or swap these assets. This is shown in the picture below.

At Midlands, Linn Energy holds around 55,000 net acres, which, in the eyes of analysts, is valued at around $2 billion. Analysts have pointed out at Athlon Energy (ATHL), which has recently purchased more than 23,000 acres in the Midland Basin for $873 million, could also go after Linn Energy’s acreage.

Linn Energy can swap its assets for other long-life, mature and producing properties. That way, the company could reduce its declining rate and increase its output. The declining rate at the Permian acreage is around 34%, considerably higher than its average rate of 23%. Moreover, the sale could also bring down Linn Energy’s capital requirements as the Permian acreage will get more than 17% of its 2014 CapEx budget.

Linn Energy has projected a coverage ratio 1.00x for the current year, which leaves little room for flexibility. Moreover, the company has based its calculations on optimistic assumptions of energy prices with natural gas at $4.84 per MCF, oil at $98.89 per barrel and NGLs at $40 per barrel and organic production growth of between 3% and 4%.

However, a deal related to its Midland properties, which results in cash inflows, could significantly improve its coverage ratio. Moreover, this can also lead towards better distributions.

Solid Distribution

Linn has a solid distribution history. Since its listing in 2006, Linn has grown its distribution, with the exception of periods between 2008 and mid-2010 when distributions were maintained at $2.52 per share on account of the economic crisis. Currently Linn pays annualized cash distributions of $2.90 per unit, which translates into an attractive yield of 10%, one of the highest in the industry.

About the author:

Sarfaraz A. Khan
Sarfaraz A. Khan is a capital market analyst and finance writer. His specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on TheStreet, Seeking Alpha, Motley Fool and GuruFocus.

Visit Sarfaraz A. Khan's Website


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