3 Reasons to Buy This High-Yielding Energy Stock

In an income-starved world, it's nice to run across a company with a high and sustainable yield. In the exploration and production space, one high-yielding company may be just what you're looking for.

It's got a unique strategy that has driven consistent growth in production and reserves, is extremely well protected from the downside risk of falling commodity prices for years to come, and offers a mouth-watering dividend yield of 7.4%. What's not to love?

A unique oil and gas producer
Linn Energy
(Nasdaq: LINE  ) is a large oil and gas company with a market cap of $7.8 billion. But Linn isn't your typical, run-of-the-mill energy explorer and producer. It's structured as a limited liability company, but taxed like a partnership. Therefore, it pays out the bulk of its cash flow in the form of tax-deferred distributions, similar to a master limited partnership. In fact, it's included in the benchmark Alerian MLP Index (INDEX: ^AMZ.A  ) .

Linn boasts more than 5 trillion cubic feet of gas-equivalent proved reserves and has a large inventory of more than 15,000 oil and gas wells, as well as around 3,000 future drilling locations. Its main producing assets are spread out throughout the country and include acreage in the Midcontinent, the Bakken, and the Permian and Hugoton basins.

A unique growth strategy
Linn's strategy focuses on acquiring older producing assets at attractive prices and then trying to get the most out of them. Due to heightened macroeconomic uncertainty, as well as weakness in commodity prices, companies are divesting a record number of assets in order to raise cash.

As such, Linn finds itself in a highly favorable position to buy very attractively priced assets from struggling companies. From the end of 2011 to April of this year, Linn bought some $2.3 billion in assets from Plains Exploration, Southwestern Energy (NYSE: SWN  ) , and BP (NYSE: BP  ) . Since the acquired assets were producing and long-lived, their value should be borne out over several years.

The $1.2 billion deal it inked with BP to acquire 600,000 acres in the Hugoton Basin of southwest Kansas seems an especially good one. The acreage is expected to yield 110 million cubic feet of natural gas equivalent -- with 63% of it dry gas and 37% natural gas liquids -- providing a significant boost to Linn's proved reserves. CEO Mark Ellis said that the purchase "is expected to provide a very steady stream of cash flow with little requirement for capital investment."

The company certainly seems to have a passion for acquiring a ton of assets. This might normally raise concern among investors, but it seems Linn's procedures for screening a deal are both highly selective and exhaustive. The company has screened countless potential assets in its search for the most compelling purchases. Just last year alone, the company closed on 12 asset purchases, yet scanned over 120.

A unique hedging strategy
The company hedges its production to what may seem like an abnormally high degree. The standard procedure at Linn seems to be: Acquire asset then immediately hedge production. A forward-thinking company, Linn has hedged most of its oil and gas production through 2016 and 2017, respectively, using swaps and puts. For oil, it locked in prices between $90 and $100 per barrel, and for gas, between $4.50 and $5.50 on average per cubic foot.

The rather extreme hedging strategy has paid off well so far. For its natural gas hedges, the company realized an average of $6.33 per mcf in the first quarter, roughly twice as much as the average un-hedged market price.

However, while Linn's hedging program limits downside risk to a tremendous degree, it also limits potential upside somewhat. Specifically, while the company has locked in what seem like attractive prices for now, oil and other commodities could move much higher in the longer term. In fact, several commentators believe this to be a likely scenario.

If this does indeed turn out to be the case, Linn's returns would be limited due to its long-term hedges. But of course, this is the price one has to pay for safety and for maintaining that eye-catching yield. And in any case, hedging for many years out is common practice among energy companies, especially those with MLP-like traits.

A high and stable yield
While its growth and hedging strategies are nothing to scoff at, the big reason it has investors buzzing is its juicy 7.4% dividend yield. While this payout pales in comparison to that of propane purveyor Ferrelgas Partners (NYSE: FGP  ) , whose dividend yield comes in at a hefty 10%, it's still notably higher than the average yield of energy MLPs, which sits between 6% and 6.5%. Even more impressive is the fact this payout has withstood the test of time.

Linn's distribution rate has been stable from Q4 of 2007 until the second quarter of 2010. Subsequently, it was raised to $0.66 for Q3 of 2010, to $0.69 for Q2 of 2011, and finally to $0.73 for the first quarter of this year.

Given the global economic turmoil and tremendous commodity price volatility in the intervening period, the steadiness of Linn's distribution is even more impressive. Moreover, it speaks to the general stability and relative insulation from commodity price fluctuations of companies with MLP-like characteristics. And finally, given the company's current payout ratio of 60% and strong expectations of future growth, the yield appears all the more sustainable.

While Linn Energy is about as well hedged as one can be, commodity prices still limit the company's upside. But one oil and gas company has found a way to profit despite volatile prices. Read more about this little-known energy equipment provider ready to soar in The Motley Fool's special free report: "The Only Energy Stock You'll Ever Need." Don't miss out on this limited-time opportunity to discover the name of this under-the-radar company. Click here to access your report – it's totally free.  

Fool contributor Arjun Sreekumar does not own shares of any companies listed above. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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