Source: LINN Energy.
It has to be tough for LINN Energy (LINEQ) investors to keep up with everything going on at the company this year. In the past quarter alone, the independent oil and natural gas company made five separate announcements regarding developments in its portfolio restructuring. This is all part of LINN's plan to trade or sell $4 billion-$5 billion worth of higher-decline, capital-intensive assets, and to replace them with $4 billion-$5 billion of long-life, low-decline MLP assets. That's a pretty significant portfolio reshuffle representing up to over a quarter of the company's $19 billion enterprise value.
Unfortunately for investors, these changes haven't done a thing to budge the company's share price this year. This is despite the fact that management believes there is "significant potential" for unit price appreciation. That, of course, begs the question of what the company needs to do to jump-start the stock.
The deck shuffling continues
With the five moves announced this past quarter, LINN has now spent a net $2.55 billion in cash that it plans to pay back once it finishes its asset sales and trades. This means LINN Energy still has much work to do. It recently hired banks to auction off its assets in the Granite Wash, which could bring in $2 billion for the company. Furthermore, the company still has several acreage blocks in the Midland Basin that it is looking to trade or sell, as noted on the following slide.
Source: LINN Energy Investor Presentation.
Once these deals are complete, LINN Energy expects that its new portfolio will have similar operating cash flow, along with a much more manageable decline rate, which will reduce its annual capital spending needs. However, no matter how successful its reshuffling plans, the key to boosting LINN's stock price lies in what comes after this portfolio transition is complete.
The key to a rising stock price
The following chart illustrates LINN Energy's dividend and stock price since it went public.
Unfortunately, that charting program assumed that when the company switched to a monthly distribution that it cut the distribution. Instead, just imagine that the orange line keeps going straight, as LINN Energy has never reduced its payout to investors. Notice also that when the orange line representing LINN's dividend goes up that its unit price also rises. The stock, though, tends to fall when the dividend stays static for some time. We can infer from this that units should rise if LINN Energy would simply boost its distribution.
When will a distribution increase happen?
LINN Energy estimates that after completing its portfolio reshuffle it should have about $103 million in excess cash flow this year, even after paying out $962 million in distributions. That leaves the company with a full-year distribution coverage ratio of 1.10 times, its best in years. However, that alone isn't enough for the company to raise its payout.
In fact, during the second-quarter earnings conference call, CEO Mark Ellis said the company's portfolio reshuffle is intended to stabilize its distribution, and that any growth in the payout would come after the company made an accretive transaction. So, step one to fueling a rise in the company's unit price would be for LINN to again start to acquire additional assets.
Going back to normal
Once LINN Energy starts making deals that move its dividend higher, the company's units should start increasing in value as well. Management actually sees the potential for the unit price to grow faster than the distribution, because shares currently trade at a discount to both its historical yield and the yield of other master limited partnerships, as noted in the following slide.
Source: LINN Energy Investor Presentation.
The last bullet point on the slide states that LINN Energy has "significant potential for yield compression," which CFO Kolja Rockov echoed on the company's conference call. This means that at the $31 unit price, investors buying today receive a yield at 9.4%. However, investors buying the company on the open market have historically only received a 7.9% yield, which would imply a nearly $37 unit price, or a 20% gain.
Investor takeaway
Successful growth of LINN Energy's distribution should help to jump-start the company's unit price. That jump-start, when combined with units simply reverting back to their historical average yield of just under 8%, has the potential to fuel the company's stock price in 2014.
