With 10-year Treasuries yielding below 2%, investors are anxiously searching for high and sustainable yields. In the energy space, one high-yielding company should more than fulfill their expectations. It's an extremely conservatively hedged energy explorer and producer with solid exposure to high rate-of-return onshore plays. And it offers a juicy 7.4% yield.
A one-of-a-kind energy company
Linn Energy (Nasdaq: LINE ) is the nation's eighth largest oil and gas company, with an enterprise value of around $14.5 billion. It boasts nearly 5.1 trillion cubic feet equivalent of total proved reserves, of which 36% are yet to be developed. The company has more than 15,500 gross productive oil and natural gas wells that maintain a balanced production mix -- 55% natural gas and 45% oil and natural gas liquids.
But Linn isn't like most energy E&Ps, for several reasons. First, the company is structured as an LLC yet taxed like a partnership. Therefore, it pays out the majority of its cash flow as tax-deferred distributions, similar to a master limited partnership. And because it lacks a general partner, like other MLPs, all investors share the growth in distributions equally.
Combining acquisitions with organic growth
Among E&Ps, I like ones that have a consistent track record of growing reserves and production. Linn definitely fits this bill. The compounded annual growth rate (CAGR) of reserves has been a whopping 65% since the company went public in 2006. And in just the past seven months, the company has increased its total reserves by 50%, from 3.4 Tcfe at the end of 2011 to 5.1 Tcfe currently.
Linn also has a real knack for acquiring mature, long-lived, low-decline assets at attractive prices. With so many energy companies divesting assets to raise cash, the company has found itself rolling in attractive opportunities as of late. Year-to-date, it has announced $2.8 billion in acquisitions, which is more than a quarter of the total value of the company's acquisitions since inception.
Most recently, the company scooped up acreage in Wyoming's Jonah Field from BP (NYSE: BP ) for a contract price just north of $1 billion. Fitting the company's criteria to a T, the Jonah field is a long-lived asset with a low decline rate and is expected to yield roughly 145 million cubic feet equivalent per day. Current proved reserves total roughly 730 billion cubic feet equivalent, but the company estimates the total resource potential to be closer to 1.2 trillion cubic feet equivalent.
Still, you may find yourself skeptical on the grounds that acquisition-driven growth is inorganic. After all, in just the past six years, the company has acquired more than $8 billion in assets. While it's true that acquisitions have been a major force in driving the company's success, organic growth has been a key driver as well. A couple of key points that may assuage concerns is that last year, organic growth in production was 40% and the company is expecting more than 20% this year.
Linn's 7.4% dividend compares very favorably with other large E&Ps. While you can certainly find higher yields in the energy space, like Ferrelgas Partners' (NYSE: FGP ) monstrous 9.9%, investors need to dig a little deeper to determine the sustainability of a company's payout.
For instance, another large E&P, Penn West Petroleum (NYSE: PWE ) , boasts a dividend yield of 7.6%. But its dividend may be in serious jeopardy, with a payout ratio approaching 140%. To keep up its payments to investors, the company is contemplating massive asset sales to the tune of $1 billion. And they're not alone.
Enerplus (NYSE: ERF ) , a Canadian oil and gas drilling and exploration company, is also having trouble servicing its dividend payments. Even after recently reducing its payout by half, its current dividend of 6.8% may have to be lowered further. The company's quarterly losses are worsening, and its free cash flow is now in negative territory.
Linn, on the other hand, has a solid track record of distribution growth. It has consistently raised its distribution each quarter since it went public in 2006. In all, Linn has grown its quarterly distribution by a whopping 81% since its IPO. Keep in mind that this distribution growth held up despite the global financial crisis and the 2008 plunge in commodity prices -- a time in which several of Linn's competitors in the MLP universe were forced to reduce or even suspend their distributions.
While the company's distribution coverage ratio did slip below 1 for the second quarter on weak pricing for natural gas liquids, it is likely to recover. In its second-quarter earnings conference call, management suggested that it expects further weakness in NGL pricing ahead but also sees recent acquisitions and a transition toward oil production mitigating the impact and bringing the coverage ratio back to healthier levels.
In this respect, Linn Energy is in a very favorable position compared with other E&Ps. While companies such as Penn West Petroleum and Chesapeake Energy are selling off, or thinking about selling off, major assets to raise cash, Linn is patiently waiting on the sideline to spot attractive deals.
I think Linn is a standout energy company. It possesses a vast inventory of low-risk, liquids-rich opportunities that sport low decline rates and long reserve lives and should keep the company humming for several years to come. And with such a large portfolio, it has tremendous flexibility in terms of its resource base and can easily shift focus to more profitable plays, as illustrated by its recent move into the oilier Hogshooter zone.
Linn's 7.4% yield is considerably higher than the average yield for the MLP asset class and appears much more sustainable that those of its competitors. It also boasts one of the most conservative hedge books of any company out there and has hedged oil and natural gas production several years into the future, which is nice, since it provides highly predictable cash flows.
However, the stock saw a huge run-up in the weeks since June 25, gaining nearly 10%. Shares currently trade at around $39, near their 52-week high. Though it might be an even more compelling opportunity if it gets back down to around $35, I think it's still a solid long-term buy at current levels.
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