Here's Why LINN Energy Isn't Doomed Despite the Panic Selling

These are tough times for upstream master limited partnership LINN Energy (NASDAQ: LINE  ) . The exploration and production giant just can't seem to catch a break. Over the past few months, it's been under a wave of attacks from analysts who claim LINN's financial holding entity, LinnCo (NASDAQ: LNCO  ) , vastly overpaid for Berry Petroleum.

It's true that the Berry acquisition took more time and resulted in greater costs than LINN management would have preferred. And investors appear to be disappointed by LINN's underlying business performance last year. However, LINN units and LinnCo shares have been massively sold off over the past few weeks despite the fact that LINN is still growing oil and gas production and pays a double-digit yield, covered by operating cash flow.

As a result, investors may want to take a few breaths and think rationally about LINN before succumbing to market-induced panic.

Why the widespread fears are overblown
The market appears to have taken an extremely bearish stance on LINN ever since it closed the Berry acquisition. Concerns about the deal surround the fact that LINN had to raise its offer for Berry. LinnCo initially offered 1.25 shares for each share of Berry Petroleum; it then had to increase its offer to 1.68 shares to finalize the acquisition. This effectively raised the value of the deal from $4.3 billion to $4.9 billion.

The offer premium has raised concerns about the level of accretion the deal will bring to LINN and LinnCo; these doubts were highlighted in a series of recent analyst downgrades. Fears that LINN overpaid for Berry's assets, in addition to the fact that LINN's most recent quarterly results disappointed, mean there's little wiggle room going forward.

However, it's important to put all of this disappointment into context. If you ignore all the expectations going in to earnings, LINN's underlying business actually did fairly well. It grew average daily production by 11% in the fourth quarter. In addition, proved reserves jumped 34%. This resulted in quarterly operating cash flow increasing by 9%.

Despite the hysteria, the distribution looks secure
It seems the market is also concerned about the security of LINN's hefty distribution, which stands at about 10% annualized. However, again it seems the fears are overblown. LINN is still generating more in operating cash flow than it's paying out in distributions. LINN distributed $170 million to unitholders in the fourth quarter. It also generated a $31 million excess of net cash provided by operating activities after distributions to unitholders and discretionary adjustments.

LINN breaks out several of these discretionary adjustments, which include things like reductions for oil and gas development costs, legal expenses, and premiums paid for derivatives contracts. Essentially, LINN provides these metrics as an alternative to the more commonly utilized distributable cash flow measure, which it no longer uses.

Plainly stated, LINN still generated more cash flow than it paid out in distributions in the fourth quarter, by $31 million. LINN will retain these funds, which should provide a cushion in subsequent quarters. And, the fact that the company expects continued growth means the distribution coverage looks to be in even less jeopardy.

LINN expects the newly acquired Berry assets to contribute to production growth in the near term. In the first quarter of 2014, LINN expects average production to reach 1.1 billion cubic feet equivalent per day, which would represent 22% growth over the fourth quarter.

The Foolish takeaway
As a result, while it's easy for investors to panic considering the significant sell-off in LINN and LinnCo in a relatively short amount of time, there doesn't seem to be any underlying reason for alarm. LINN's fundamentals aren't broken by any means. The company is still doing what it does best, which is to acquire, explore, and produce oil and gas.

And management expects growth this year. That's why, although there are never any guarantees in the investing world, LINN does not appear to be a house of cards as the cascade of negative analyst sentiment suggests.

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Read/Post Comments (5) | Recommend This Article (11)

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 25, 2014, at 10:42 AM, RumRunnerBand wrote:

    Owning LINE for capital growth is probably not the point of an MLP in the first place. It seems to me that MLPs are straight forward income instrument and trading the stock defeats the purpose of the tax advantages. LINE is one of my income investments that I have owned for years and despite the ups and downs of the unit price I have collected a nice income stream. Insiders seem much less worried than do the talking heads as they have bought over $1 million worth of the units in January.

  • Report this Comment On March 25, 2014, at 11:05 AM, zorro6204 wrote:

    Everything you say is true, but that does not mean LINE will recover to anything near it's previous norm. There is no "correct" price to yield for an MLP. it's whatever the market will pay. In the past LINE was viewed as a safe harbor, due to its conservative hedging and size. Smaller MLP's like VNR traded at least a point in yield higher, often two or three above LINE, which traded in the 7-8% range.

    But that premium was based on a perception, and mindsets change. A lot of damage has been done by these attacks, and bad luck and an unfortunately messy acquisition did not help. Is the distribution secure? Of course. Should they return to distribution growth? Almost certainly, the coming asset deals could add as much as 30-60 cents to DCF (we can say that), according to one analysis that seemed reasonable.

    Does that mean LINE will trade at $35, $40, higher? Absolutely not. The days of LINE trading at a premium may be over, or deferred for a long time. A $3 distribution capped at a 9% yield is $33. JPM may be overly bearish, but not by that much. Hope that's wrong, but the recent price action does not provide much hope.

  • Report this Comment On March 25, 2014, at 2:53 PM, Lou1s wrote:

    Analysts are short term investors, gotta make that money now. If a company is having a bad hair day, analysts beat it to a pulp. Started purchasing LINE and LNCO in 2010, have added to my positions when necessary. Dividend re-investment has done wonders for me with these two stocks, will continue to do the same. I'm long LINE and LNCO. GO TEAM!

  • Report this Comment On March 25, 2014, at 6:21 PM, jack2222m wrote:

    ? Will LNCO again trade at a premium to LINE? Why did the Berry deal change that...jack

  • Report this Comment On March 26, 2014, at 3:41 PM, GirlScoutDad wrote:

    I'm in a contrarian mood here, so I'm going to buy more LINE and increase my position (original entry around $14/share some years ago).

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Bob Ciura

Bob Ciura, MBA, has written for The Motley Fool since 2012. I focus on energy, consumer goods, and technology. I look for growth at a reasonable price, with a particular fondness for market-beating dividend yields.

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Related Tickers

8/28/2015 3:59 PM
LINE $3.30 Up +0.40 +0.00%
Linn Energy, LLC CAPS Rating: ***
LNCO $2.98 Down +0.00 +0.00%
Linn Co, LLC CAPS Rating: ***