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Linn Energy LLC -- an MLP on Steroids

April 22, 2010 | About:
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When searching for the best income stocks on the planet, it's hard to beat master limited partnerships, which often go by the acronym MLPs. These partnerships exist to pass earnings to their shareholders. A variation on the MLP theme adds a feature that boosts income even more.

MLPs, because of their structure, pay no tax. This allows them to use proceeds that most corporations would have to allocate toward paying taxes to boost the return for their unit holders.

But MLPs are burdened by a thing called incentive distribution rights. MLPs usually have a general partner that claims the right to a percentage of the distributions. These distribution rights often gobble up as much as one-third of the money available for distributions. Limited liability companies, however, have no general partner and thus pay no incentive distribution rights. This frees them up to pay higher distributions.

Linn Energy LLC (LINE) is one of the 25 largest domestic independent oil and gas companies. It's the largest public exploration and production enterprise of its type. The company focuses on developing and buying U.S. oil and gas wells.

As of Dec. 31, Linn had about 1.8 trillion cubic-feet equivalent of proved reserves, a production life of about 20 years. Linn makes money selling this petroleum and has increased its earnings and distributions by upping its production and making acquisitions. Linn's growth strategy is to buy established oil- and gas-producing properties that generate steady cash flow.

The formula appears to be working well. Linn achieved a stratospheric total return of more than +100% for 2009. With no general partner to burden its cash flow, Linn has been able to steadily grow quarterly distributions since its initial public offering in 2006 by +58%, from $0.40 to $0.63. Quarterly distributions have been $0.63 since the first quarter of 2008. At today's share price, that payout translates to a stellar 9.6% yield ($2.52/$26.30).

The price and demand for oil and gas plummeted in the recession riddled year of 2009. Technically, Linn's earnings were much lower. The LLC had a net loss of ($296 million) or ($2.48) per share in 2009. However, those numbers included unrealized non-cash loses on derivative contracts.

A more accurate assessment of the company's financial position is adjusted net income. This adds back unrealized derivative losses as well as depreciation to the bottom line. Adjusted net income for 2009 was $207 million, or $1.73 per share, versus $175 million, or $1.52 per share, in 2008.The company's hedging strategies were remarkably effective and enabled it to receive significantly higher prices for both oil and gas. Linn is 100% hedged against falling prices through 2011. Though oil trades in the $80 range, Linn has contracts that allow it to receive an average price of $92.25 per barrel for oil. Natural gas is at about $4; Linn is selling it for $8.87 through 2011.

Linn is price-protected, and it's also expanding its holdings. It recently announced two huge acquisitions, natural gas properties in the Antrim Shale of northern Michigan, for $330 million. It also bought more oil properties in Texas' Permian Basin for $305 million. The Michigan properties are expected to add natural gas equal to almost 14% of 2009 production. The oil from the Permian Basin properties should produce about 2,800 barrels of oil a day.

Linn issued 15 million additional units to help pay for the acquisitions, but the effect won't hurt earnings much, as the company had more than 130 million units outstanding already. Before the acquisitions, Linn estimated that it would earn distributable cash flow of $2.78 per unit in 2010, which would cover current distributions of $2.52 per unit by 1.10 times.

Looking forward, predictable cash flows should enable Linn to maintain the current distribution and earnings accretion from recent acquisitions and may prompt a distribution increase in the near future.

A solid oil and gas production business with a long reserve life combined with a structure that enables Linn to pay the maximum distributions make Linn a fantastic income stock in the short and long term.



Disclosure: Tom Hutchinson does not own shares of any security mentioned in this article.

Rating: 3.8/5 (9 votes)

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