LINN Energy LLC Is "Hungover"

Investors aren't too happy with LINN Energy's  (NASDAQ: LINE  ) guidance for 2014, and it shows in both corporate shares and partnership units. 

Source: YCharts

As we can see from the chart above, both LINN Energy and Linn Co (NASDAQ: LNCO  ) have dropped by high single digits in just the last month. Investors are disappointed by a few things, including a very thin coverage ratio, a drag from increased share count as a result of the acquisition of Berry Petroleum, and a fairly light capital program for 2014. All of these points stem from LINN's acquisition of Berry last year, which was an acquisition that faced unexpected challenges due to a regulatory inquiry and a falling stock price in the latter part of last year. 

Last year LINN Energy faced an informal inquiry from the SEC, part of which was in regards to the Berry Petroleum acquisition. In addition, the fallout in the company's stock price, which followed in the wake of several negative media articles, jeopardized the acquisition because the transaction was done by issuing new shares of Linn Co. In response to the market volatility, LINN upped its offer for Berry Petroleum from 1.25 shares of Linn Co for each share of Berry, to 1.69 shares of Linn Co for each share of Berry. This higher share count resulted in a much higher obligation for dividends and distributions, and while the Berry acquisition has certainly added production, it has not thus far been enough to increase per share cash flow in excess of distributions or dividends. In other words, the Berry transaction has not thus far been accretive; it doesn't look like the deal will be accretive for at least this year.

Razor-thin coverage
In the company's guidance for this year, management expects to have only $12 million of cash in excess of distributions paid, putting LINN's effective coverage ratio at only 1.01 times for this year. Just to clarify, I do believe that LINN's distribution is secure in 2014, despite the thin coverage ratio, thanks to the company's hedging policy. One hundred percent of both gas and oil are hedged for 2014, and so only a substantial production shortfall could jeopardize the distributions. 

However, one of management's goals is to raise the distribution by at least mid single-digits every year. That 1.01 times coverage ratio is actually based on the current distribution. Therefore, I struggle to see how management will be able to raise the distribution this year without making an accretive acquisition. 

Possible asset swap
LINN is primarily a driller for high-margin oil and gas located on mature acreage. While the acquisition of Berry Petroleum was largely of this type of acreage, some of the acreage was for horizontal drilling. LINN now holds significant horizontal drilling inventory in the Midland Basin in west Texas. This acreage could provide significant growth but requires lots of capital to develop, something that is not LINN's specialty. As a result, it is looking to possibly sell or swap this chunk of acreage. In doing so, LINN may lower its overall capital intensity and free up precious capital to drill higher-margin, lower-maintenance acreage. Such a sale could be one way to make the Berry acquisition more immediately accretive.

The hangover
LINN had a tough time closing up the Berry acquisition, and it had to substantially increase its offer to do so. This has made Berry that much harder to "digest." This has resulted in a very tight coverage ratio this year, which will most likely lead to a flat distribution as well. In addition, LINN now has a substantial amount of west Texas acreage, which doesn't fit the company's core competency. After a flurry of intense and often dramatic activity in 2013, I believe we should give LINN at least one year in which to recuperate. By 2015, I believe LINN will be boosted by solid organic production growth and will continue to steadily increase that distribution once again. In the meantime, yes, the current distribution is safe. 

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Read/Post Comments (8) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 11, 2014, at 12:32 PM, dsandman999 wrote:

    "In the meantime, yes, the current distribution is safe"

    At a time of less than 3.8% 30 y and 2.8% 10Y treasurey, a 9.20% yield on a a safe dividend, makes it a buy. You are being well paid for the year you wait with a good chance that dividend increases will go up next year.

    While I know from before that 100% of oil and NatGas are hedged for LINE, is that true of the assets aquired from BRY? I do not think BRY had 100% of either hedged. With WTI at over $101/Brl, that could be a great boost to the bottom line.

  • Report this Comment On March 11, 2014, at 1:11 PM, Frederick wrote:

    WOW, what a terrible title. Foolish for sure and not in a good way. Nothing about the terrible weather. Nothing about the fact that these two large company's just wrapped the deal. Like so many today this author expects instant results. If they don't get them you get articles like this with bashing headlines. Very foolish. Again, not in that whimsical way that the Motley Fool usually plays.

    You guys hyped this stock before and after the sale. Now you come out with this.

    You have lost some credibility with me Motley Fool. I know I am not alone. This article helped push the stock over a buck lower. As a shareholder I have a finger that reps what I think of your bias report without all the facts.

    Would I be the fool for listening to anything further from you? You tell me.

  • Report this Comment On March 11, 2014, at 1:24 PM, robertbruno wrote:

    hes right on

  • Report this Comment On March 11, 2014, at 1:35 PM, leonardo98 wrote:

    Motley Fool,

    Consistent with Frederick's remark, you are both a "fool and a fooler"

  • Report this Comment On March 12, 2014, at 11:11 AM, critterlitter wrote:

    Certainly, the article title could have been different and a bit more upbeat, given the contents of the article --- a bit contradictory, however; somewhat true also.

    It's tough sometimes to read articles that are not the most positive about one's investment, and certainly, LINE/LNCO holders have experienced their share (no pun intended) of financial and emotional "discomfort" over the last three months or so.

    Investing/trading is never always rose pedals, and when dealing with roses, we always have to be willing to deal with the thorns also --- or find another garden to spend one's time in.

    Relatively speaking to my overall portfolio, I am in very heavy with LNCO --- probably too heavy when one talks about diversification, but that was my conscious call. Recently, I have added to my position two times --- once after the quarterly and once on 3/11 on a sizeable dip.

    My reasoning being that is that nothing has changed with them in the last month or so --- everything is pretty much status quo. If I believed in them two months ago, why would I change now? Well, I haven't, as evidenced by another 1000 shares added.

    Once again, we all must remember why we are buying (or just holding) this stock --- it's because we believe, in the longer term, that they will produce numbers that will not only substantiate and support their distribution even more solidly, but also show the market that their share price is worthy of more than what the market presently thinks it's worth.

    I'm staying LONG and solid, but recent SIZEABLE share price drops can be quite disconcerting. However; I have to remind myself why I initially bought into LNCO, and that reminder made me buy more (and more again).

    Time (and I am not talking a month or two) will tell whether I was grabbing at a falling knife. I see it the opposite --- the opportunity to buy "discounted" shares due to a market that feels queasy about LINE/LNCO.

    Even Warren Buffett's take on a generic scenario makes me feel just a touch better about the situation: (If nothing has fundamentally changed with a company) Do the opposite of what the market is doing. When they are selling, you are buying.

    Think LONG-TERM, folks. And also remember --- while we're waiting for share (re-)appreciation to take place, we're grabbing a 9 - 10% dividend and we're buying "cheap" shares on a monthly basis.

    Steady as she goes. 2014 may very well be a "hangover" year, however; in the LONG-TERM, we're doing the right thing...

    Peace.

  • Report this Comment On March 12, 2014, at 11:52 AM, HoerthCM wrote:

    I apologize for the title if it upset anyone. I'm the author, and I take responsibility for it. The title was my idea, and not the idea of Motley Fool.

    In fact, the title was just meant to be a quick way to articulate that it might take some time for Linn to resume growing cash flow per share. This was not meant to be a 'negative piece.'

    Thanks for the comments, everyone.

  • Report this Comment On March 13, 2014, at 11:37 AM, LeapDaddy wrote:

    Can someone make a distinction between LINE and LNCO. Why each exists? Why own one rather than the other?

  • Report this Comment On June 23, 2014, at 11:17 AM, GraphicD wrote:

    LeapDaddy - I had the same question. Cramer answers it here: http://www.cnbc.com/id/49438008

    Basically it comes down to it getting a better tax rate off of LinnCo.

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