Is LinnCo LLC’s Dividend Finally Sustainable?

Source: Linn Energy LLC.

LinnCo LLC (NASDAQ: LNCO  ) investors have received just one tiny dividend increase since the company went public in 2012. This is because the company's only asset is units of LINN Energy LLC (NASDAQ: LINE  ) , which has had trouble fully covering its distribution during that time frame, making it impossible to raise its distribution. These troubles have made some investors wonder whether LinnCo's own dividend is sustainable. Let's take a closer look.

LINN Energy's coverage ratio
During the past two years, LINN Energy's distribution coverage ratio has averaged 1.07 times, as the company has retained an average of $11 million each quarter after paying its distribution to investors, as the following chart notes.

Source: Linn Energy press releases, investor presentations and author's calculations.

While the company's overall distributions to investors have gone up, its payout per unit hasn't. This is because the company has issued new units to acquire additional assets; however, the added cash flow from these new assets hasn't been enough to overcome weakening cash flow from the company's legacy assets.

That said, the company's distribution coverage ratio has been adequate; it's just not high enough for the company to boost its payout. The number that LINN Energy's management wants to see was noted by CEO Mark Ellis on the company's second-quarter conference call. He said that LINN Energy looks at "having the sustainability to generate coverage or excess cash, I guess, at about 10% excess. So the 1.1 level sustained for period of time is when we think about stepping into distribution growth."

Sustaining cash flow
In order to get to the 1.1 times coverage ratio on a sustainable basis, LINN Energy is in the middle of an aggressive reshuffle of its oil and gas portfolio. It's selling or trading away $4 billion-$5 billion of assets that have high production decline rates, which require the company to spend higher amounts of capital in order to keep production and cash flow flat. It's replacing these assets with $4 billion-$5 billion of long-life, low-decline assets that fit better within Linn Energy's MLP model.

 

Source: Linn Energy LLC 

The rationale behind the reshuffle is specifically to stabilize the company's cash flow to provide investors with a sustainable dividend. According to CEO Mark Ellis, "This transactional asset rotation is expected to result in a more stable base business and sets the stage for future growth." Further, Ellis said that the company's most recent asset sales and acquisitions put the company "in an excellent position to deliver stable cash flows and a sound platform for future growth."

Linn Energy still has a few moves left to complete. However, once this transformation is finished, it believes its distribution will be much more secure and ready to grow. And, because LinnCo's only asset is LINN Energy's units, as LINN Energy increases its distribution, LinnCo's dividend will rise, as well.

Investor takeaway
LINN Energy is working to reshuffle its portfolio to stabilize its cash flows. These moves will also make LinnCo's dividend much more sustainable. In fact, there's a lot of potential for that dividend to grow as LINN Energy adds new assets that move the needle on its cash flow.

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  • Report this Comment On August 28, 2014, at 6:22 PM, rlp2451 wrote:

    By divesting Granite Wash, Linn will be giving up close to 20% of it's production and more than that in revenue (and higher margin products), and trading it for low margin natural gas. Although the removal of GW also reduces capital expenditures, I question whether the trade is going to be cash flow positive enough to move the needle significantly.

  • Report this Comment On August 28, 2014, at 7:15 PM, TMFmd19 wrote:

    The revenue number doesn't really matter all that much for Linn. Cash flow is they key here and it says that these trades/sales should have little to no impact on cash flow. So, you're right these trades won't move the needle on that, but they aren't supposed to do that. They are being done to stabilize cash flow so that the next deal can put it over the top and grow cash flow.

    Matt

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