Source: LINN Energy LLC.
The market is deeply worried about LINN Energy's (LINEQ) debt situation, which is why its unit price, as well as the stock price of its affiliate, LinnCo (NASDAQ: LNCO), has been hammered over the past year. LINN is well aware of these concerns and addressed them head-on during its third-quarter conference call. Here are five things its management team wanted investors to know about its current financial situation.
1. We have a firm grasp on the situation
After walking investors through the company's most recent bank credit facility redetermination, CFO Dave Rottino said that the company's management is "very mindful of both our current liquidity position and our balance sheet leverage."
He continued: "We're committed to living within cash flow in this commodity price environment and are currently generating free cash flow. We expect to continue to generate free cash flow in 2016, even if commodity prices remain at current levels."
Rottino noted that the company knows that its liquidity and leverage are a concern, which is why it has committed to not only live within cash flow but also to take advantage of its currently robust hedge position to generate free cash flow through the end of next year. That's also why it made the painful decision to cut and then suspend its distribution earlier this year, because it wanted to free up even more cash flow so that it could really shore up its financial position.
2. We're comfortable with our liquidity
In addressing its liquidity situation more directly, Rottino noted:
As we think about kind of minimum liquidity levels, I'd say we'd like to maintain at least $500 million of undrawn capacity [on its credit facilities]. And ... at the end of this quarter [we] were at $790 million. So, obviously things will change. ... But I think ultimately that's where we'd like to be.
In other words, at the moment LINN is comfortable with its liquidity because it's well above the company's current minimum threshold. That said, the available capacity of that borrowing base, which makes up the bulk of the company's liquidity, started the year at $2.2 billion, but that availability was reduced at both the spring and fall redetermination periods. So its quite possible that the borrowing base will be cut again when LINN's credit goes under review next spring, and it needs to prepare for that possibility.
3. We know our leverage needs to go lower
Rottino also addressed questions on its leverage target but was a bit lighter in the specifics:
As far as leverage targets, that's really difficult to say. I'd say in this price environment, leverage is obviously not where we'd like it to be. But we're very focused on living within cash flow, continuing to work at it [to] reduce leverage. ... So I don't have a specific target other than it's obviously lower than where it is today.
Through a series of bond exchanges and debt repurchases, LINN Energy has reduced its net debt by $1.8 billion since the start of the year, which has lowered its annual interest expense by $70 million. But it still has $9 billion in debt outstanding, which is still too much leverage in the current oil price environment, suggesting that additional moves need to be made.
4. We still have a lot of flexibility
Going forward, LINN plans to continue to address both its weakening liquidity position and its overall leverage. Rottino noted that the company has a range of options at its disposal to accomplish both objectives. However: "At the end of the day, it's an economic decision as well as a need for incremental liquidity. It's not something that we have to have right now, but we have the flexibility to raise it, if and when it makes economic sense for us."
LINN Energy has two important things going for it right now: flexibility and options. That means that it doesn't have to do something drastic to stay afloat and can instead monitor the market and strike when it makes sense.
5. Here are our initial thoughts on 2016
While most of the call focused on LINN's financial situation, CEO Mark Ellis also provided his initial thoughts on 2016:
We haven't really done our budget for 2016. As we look out, what I would tell you this year we're spending around $470 million in oil and gas capital. As we think about it next year, my guess is it'll probably come inside of that, a little less, but at the end of the day, we'll have all of our cost savings associated with our capital program.
In other words, LINN expects to spend roughly what it spent this year to keep its production basically flat. That production is expected to generate enough cash flow to more than cover the associated capex spending while also covering the company's interest payments and leaving it with a substantial amount of free cash flow thanks to its strong hedge position. That excess cash flow can be used to improve the company's financial position, with LINN either paying down some of the $3.5 billion of outstanding borrowings on its credit facility or buying back additional senior notes at a discount.
Investor takeaway
The management team of LINN Energy and LinnCo is well aware that it's walking a financial tightrope right now. The team does, however, have a handle on the situation and is addressing both liquidity and leverage. So while LINN isn't out of the woods just yet, it has both time and flexibility to address its problems, though it still isn't yet to the point where its operations would be sustainable if $40 is the long-term oil price.
