Source: LINN Energy.
LINN Energy (LINEQ) switched to paying distributions to investors monthly in July 2013. That change was part of a trend within the upstream master limited partnership sector to provide its mainly income-seeking investors with a monthly stream of income. This move helps to better align an income investor's expenses, which are typically monthly, with a less lumpy income stream. With that in mind, let's take a closer look at LINN Energy and its monthly payout.
LINN Energy 101
For investors who are not familiar with LINN Energy, it is an oil and gas producer with a bit of a twist. The company owns and operates 26,000 oil and gas wells around the country. These wells have a reserve-life index of 17 years, which is the hypothetical amount of time it would take to deplete all of the company's reserves at its current production rate. Those reserves total more than 8 trillion cubic feet of natural gas equivalent, which for perspective is roughly enough to meet the energy needs of 8 million households for 15 years.
LINN Energy's twist is in its structure. As a master limited partnership, the company doesn't pay corporate taxes, but it must send all of its income to investors. That means virtually all of the money it makes from selling oil and gas is returned to investors each month. Even better, the company extensively hedges its production so that it's not affected by volatile commodity prices. Because of this, 100% of its cash flow is protected in 2014, with substantial protection in future years. As shown in the slide below, that is better than almost all of its competitors.
Source: LINN Energy.
Size matters, but safety is more important
LINN Energy currently pays out $2.90 in distributions per unit on an annual basis. At the company's present trading price, that produces a yield of just over 11.5%, which makes LINN Energy a very high-yield investment.
While having a high yield is often a warning sign, that's not the case when it comes to LINN Energy. Its distribution to investors is relatively safe and growing safer by the day. In fact, over the past two years LINN's distribution coverage ratio has averaged a solid 1.07:
Source: LINN Energy press releases.
In order to simply maintain its monthly payout, LINN Energy needs a coverage ratio of about 1, so the company has accomplished that with a 7% margin of safety. That being said, we would actually prefer the margin of safety to be a bit higher, as the company aims to maintain a 1.1 ratio.
Over the past year, the company has diligently worked to improve its coverage ratio. This included a major portfolio reshuffle to shed assets that did not produce the steady cash flow LINN needed to maintain, let alone grow, its monthly distribution to investors. This reshuffling reduced LINN's annual production decline rate to about 15%, which is expected to save the company $300 million-$400 million in capital expenses each year while having little to no negative impact on operating cash flow.
With that portfolio reshuffling largely complete, the company can now focus all of its attention on growing its distribution to unit holders. This growth will come from acquiring additional oil and gas assets that extend the company's reserves and improve its cash flow.
Monthly income stocks are a great way to match expenses with income. LINN Energy's generous payout enables investors to cover more expenses than many other stocks that come with monthly dividend payments. Investors looking for monthly income should take a closer look at the oil and gas-fueled income stream provided by LINN Energy.
