Linn Co and Vanguard Natural Resources: 2 High-Yield Stocks to Buy Today

With interest rates still at historic lows and traditional high-yielding stocks being bid up to frothy levels, income investors are struggling to find good places to invest. This article points out three quality energy companies with bright futures and yields that are not just high, but also safe and set to grow substantially.

Adam Galas
Adam Galas
Jul 17, 2014 at 12:01PM
Energy, Materials, and Utilities

Income investors looking to find high-quality, high-yield investments need not look no further than the energy sector, where America's energy boom is breaking records and making many company's vast and growing fortunes. This article highlights three oil and gas producers who have long track records of successfully growing their distributions and who have strong growth catalysts to continue doing so for many years to come.

Vanguard Natural Resources (NASDAQOTH:VNRSQ), Linn Energy (NASDAQOTH:LINEQ), and its non-MLP equivalent Linn Co (UNKNOWN:LNCO.DL) yield 8%, 9.3%, and 9.6% respectively, and each has strong growth catalysts that will not just maintain the current distributions but grow them strongly over the next decade.

Vanguard Natural Resources: king of natural gas 
Vanguard Natural Resources IPOed in 2007, and since then its proven itself a master at growing through acquisitions, 21 to be exact, totaling $3.4 billion.

Those acquisitions have allowed Vanguard to grow its reserves 2,627%, production 2,667%, and its distribution by 5.8% annually.

Vanguard has 1.8 trillion cubic feet equivalent of gas reserves, 66% of which is natural gas. Its latest acquisition, the $581 million Pinedale and Jonah gas fields in Wyoming, increased its reserves by 80% and production by 55% -- and it's 80% natural gas. Most energy producers are now turning toward higher-margin oil, but Vanguard Natural Resources is doubling down on gas, choosing to massively invest in the Pinedale and Jonah field with 6,000+ potential drilling sites. As I'll now explain, there is good reason for this. 

The Energy Information Administration (EIA) just reported that the US natural gas inventories are 40% below their five-year averages. 

The reason is low natural gas price causing the number of drilling rigs focused on gas to drop to unsustainable levels. In fact there are now five times as many oil rigs as gas rigs in the US.

This is a strong reason natural gas prices are likely to recover in the short-term. In the long term, gas exports are likely to raise the price and send Vanguard's cash flows and distribution soaring. 

Through April the Department of Energy has approved six LNG (liquefied natural gas) export terminals capable of exporting 9.3 billion cubic feet/day (bcf/d) of gas, about the same capacity as Qatar, which is one of the largest LNG producers on earth. However, the total amount of US LNG export capacity awaiting approval is 30.55 bcf/d, which represents 42% of current production.  

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Even if none of the additional LNG terminal get approved, by 2024 the approved terminals are expected to export 10% of projected US gas production, resulting in higher prices that will help Vanguard's profitability and provide cash flows to grow the distribution. Further help will come from gas exports to Mexico, which the EIA believes will increase 300% by 2040. However, there is another growth catalyst that I would like to bring to your attention -- Vanguard's Permian assets. 

The Permian Basin has been in the news a lot recently, what with its 75 billion barrels of recoverable oil (estimate is up 50% since 2013) and being the basis of major oil deals for Linn Energy. Vanguard owns 94,231 net acres of Permian land, containing 42.3 million barrels equivalent of oil and making up 14% of its reserves. With a 9.1% annual depletion rate compared to some shale wells that report 90% declines, Vanguard may be able to use these valuable acres as currency for major accretive acquisitions in the future.

Linn Energy: latest deals set it up for major distribution growth
Linn Energy had a rough 2013:

LINE Total Return Price Chart
LINE Total Return Price data by YCharts

With the Berry Petroleum acquisition's cost overruns resulting in a coverage ratio just below one, Linn's yield was threatened, and it looked like distribution growth was a thing of the past.

The problem was that Linn Energy was sitting on 55,000 acres of Permian land that would require expensive horizontal drilling to exploit and face high depletion rates. For an MLP that has to pay out almost all its earnings as distributions, this is unacceptable. So Linn Energy traded 25,000 acres of this land to ExxonMobil in exchange for 500,000 acres of Hugoton, Kansas shale with a decline rate of just 7%.

This lowered Linn Energy's capital costs and depletion rate, and it improved its cash flows, securing the distribution. In its next deal, Linn Energy bought 900,000 acres from Devon Energy for $2.3 billion. To pay for it Linn Energy will sell 147,000 acres of Granite Wash assets, which have depletion rates of 40%, to gain 80% gas assets with depletion rates of just 14%. The combination of these two deals will save Linn Energy $400 million in annual capital expenditures, cash that can now be used to once more grow the distribution -- hopefully at its historic rate of 3% to 4%.

Foolish takeaway
Long-term income investors need look no further than Vanguard Natural Resources, Linn Energy, and Linn Co for sources of high-quality yield and market-beating total returns. Both partnerships have proven track records of successful deal making and production growth that has rewarded investors with steadily increasing income and capital gains. Vanguard Natural Resources and Linn Energy's latest deals prove that track record remains intact and both partnerships remain a buy today.