Is Jim Cramer Wrong on This One?

Jim Cramer recently issued a bearish call on LINN Energy LLC  (NASDAQ: LINE  )  and its parent company LinnCo LLC  (NASDAQ: LNCO  ) . This could have opened up a perfect buying opportunity for investors as both investments took a hit on the announcement. While Cramer did say that he liked both as income plays considering that both LINN Energy and LinnCo offer yields of 10%, he said that investors should ditch those companies in favor of Kinder Morgan Energy Partners. Kinder Morgan is a great company, but that doesn't mean investors should be jumping ship just yet.

Major reserve bolstering
LINN Energy has been laying down the framework for future payouts, which will come from its proven reserve base. To do so, LINN Energy grew its proven reserves by 33% as it completed the Berry Petroleum acquisition last year. 

 Proved Reserves Table   (Bcfe)
Proved reserves at December 31, 2012  4,796
Revisions of previous estimates due to price 52
Revisions of previous estimates due to PUD SEC 5 year rule (109)
Performance revisions (100)
Purchase of minerals in place 1,610
Sales of minerals in place (73)
Extensions, discoveries and other additions 527
Production (300)
Proved reserves at December 31, 2013 6,403

Source: LINN Energy's Fourth Quarter Update and 2014 Outlook 

While most of LINN Energy's reserve growth came from its acquisitions, it still shouldn't be understated that its extensions and discoveries uncovered 527 billion cubic feet equivalent (Bcfe) of additional resources. This outpaces the rate that production took away from LINN Energy's reserve base, which is a sign that LINN Energy isn't totally dependent on additional acquisitions to fund future growth.

From 2012 to 2013, LINN Energy shifted its reserve mix from 46% liquids to 53% liquids, which should keep trending in that direction as 100% of LINN Energy's 2014 budget is focused on liquids plays. 

A love for liquids
LINN Energy is serious about tapping into liquids plays, which is why it's spending the largest portion of its budget this year on the Permian Basin. With 25% of LINN Energy's 2014 budget going toward the Permian, LINN Energy is trying to develop its 160 MMBoe of proven reserves in the region (which is 80% liquids.) By running an average of six rigs in the area this year, LINN Energy will be able to slowly add to its 25,000 bpd of output from the Permian and could potentially dig up additional resources. 

In the Uinta Basin, LINN Energy has posted some very strong numbers. By completing more wells than expected, production climbed 29% to 10,000 boe/d last quarter versus the same quarter in 2012. LINN Energy was able to bring more wells online than previously expected "due to better than expected drilling results from improved operational efficiencies, such as reduced drilling cycle times."

To add a cherry on top, management is seeking to "develop its marketing options through its initiative of shipping crude oil to markets outside of Utah via railcar," which means find markets that will pay LINN Energy more for its output. Its Uinta Basin assets offer LINN Energy one of its best chances at boosting liquids output after the Permian, which is why 13% of LINN Energy's budget is going toward the play. 

Follow the money
Last year, LINN Energy and Berry Petroleum spent a combined $1.8 billion on capex, but LINN Energy is going to cut that down to $1.6 billion this year while still growing output. Production averaged 889 MMcfe/d in the fourth quarter of 2013, which was an 11% increase over last year. LINN Energy is guiding for 2014 production to average between 1.07 Bfce/d-1.14 Bfce/d, which will come from 3%-4% organic growth and the full integration of Berry Petroleum's assets.

As LINN Energy spends less yet sees free cash flow rise from a better liquids production mix and higher levels of output, you can bet on a rising coverage ratio. This year, management is guiding for the distribution to be fully covered, which is justified in part by LINN Energy's rising levels of excess cash after distributions have been paid. In LINN Energy's latest quarter, its net cash provided by operating activities rose from $206.5 million to $225.7 million year over year. After factoring in other adjustments, LINN Energy's surplus cash after distribution payouts rose to $31.5 million from $6.6 million during that same time period.

Foolish conclusion
LINN Energy and LinnCo (which owns units of LINN Energy) have a perfect business plan to steadily grow over the next few years. With rising production levels being propelled by higher liquids output, LINN Energy is expanding both its revenue and margins. More revenue and larger margins leads to a bigger pool of distributable cash flow, which can be converted into a higher payout for unit holders of LINN Energy and shareholders of LinnCo.

This is why I don't understand Jim Cramer's bearish call on LINN Energy and LinnCo: everything is in place for the payout to either rise or at least become safer. While bears may point toward LINN Energy's $9.2 billion in net debt, shareholders don't need to be alarmed as almost all of that debt isn't due until 2019 or later. 

With LINN Energy's coverage ratio expected to be over one this year, both LINN Energy and LinnCo's payouts will be fully funded and secure. Even if there was no distribution or dividend increase, investors would rake in a safe 10% gain each year. On top of that, LINN Energy has $2.435 billion in liquidity from its credit facility just in case.

LINN Energy and LinnCo may not offer the highest levels of growth, but for investors looking for a ridiculous high yield that is sustainable to boot, look no further than these two investments. Jim Cramer is wrong to say investors should pile out of a 10% yield just to trade it with a 7.5% yield (Kinder Morgan's); instead, why not diversify and take both.

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Read/Post Comments (8) | Recommend This Article (5)

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 28, 2014, at 12:40 PM, zorro6204 wrote:

    Diversify? Despite Crammer's supposed devotion to the concept, in practice, he . . . doesn't. It's always "best in breed" and any other security in the same business is dismissed; "No no no, I want you in Company X . . ." he yammers.

    Of course you should diversify within a space, there are many good MLP's to choose from.

  • Report this Comment On March 28, 2014, at 12:41 PM, AFMS wrote:

    Listening to Cramer is not a good strategy for investors. He is only an entertainer on television. He cares about ratings only

  • Report this Comment On March 28, 2014, at 12:42 PM, ffbj wrote:

    Cramer has always been a best of breed sort of guy.

    Not saying he is right on this, but just that he likes KMP better. Personally not a big fan of MLP's due to the tax implications.

  • Report this Comment On March 28, 2014, at 12:42 PM, WordDog wrote:

    How often is Cramer right?

  • Report this Comment On March 28, 2014, at 1:11 PM, remmike wrote:

    Many times Cramer gets'm out at the bottom after putting'm in at the top or near top ...He's a trend follower not a leader .....And his Fast Money trader days as a Hedge Fund manager infect his thinking at times .....You have to be very inexperienced in stocks to find Cramer useful IMO.

  • Report this Comment On March 28, 2014, at 1:28 PM, EvereadyDrLove wrote:

    I followed Jim Cramers advice once. Once!

  • Report this Comment On March 30, 2014, at 12:45 PM, WordDog wrote:

    ffbj: "Personally not a big fan of MLP's due to the tax implications."

    Don't understand this. One of the big appeals of MLPs is the way they are taxed.

  • Report this Comment On March 30, 2014, at 6:38 PM, callumturcan wrote:

    MLP's have a favorable tax status for sure, but when individual investors purchase MLP units you have to do a little more at tax season to correctly file your taxes. That is what I would assume ffbj's point was, which is important to remember but I still like MLP's because their "complicated" tax structure results in a fatter income payment in my pocket. I'll deal with the IRS, but with a pocket full of hefty distributions.

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