Oil and gas income producer, LINN Energy (LINEQ), along with its affiliate LinnCo (NASDAQ: LNCO), will report first-quarter earnings on April 25 before markets open. It's an important report for LINN which has been under the spotlight of short sellers that have questioned the company's true value proposition to investors. While the company has done a good jobs to alleviate investor concerns, the upcoming report needs to put them completely at ease. With that as context, here are three things I'll be watching for in the report.
The big deal
Last quarter LINN and LinnCo stunned the investment world by announcing a $4.3 billion deal to acquire Berry Petroleum (NYSE: BRY). The all-stock deal is expected to close at the end of the second quarter. With a deal as large as this one, it's important to watch to make sure everything is still on track.
In one sense, the Berry transaction is a transformational deal for LINN. It shifts the reserve mix from 46% oil and liquids to 54%, as Berry's reserves are 75% liquids. Even more important is that those reserves are very oil-focused; three-quarters of the reserves are actually oil. However, while the deal is its largest, and more complex than a typical deal, it's really just business as usual for the highly acquisitive LINN.
Because of the short seller comments about its hedging practices, LINN has decided not to purchase any puts this year. That begs the question: How does LINN plan to hedge that portion of its production going forward? It could use swaps exclusively, or it could take a page out of Berry Petroleum's book and begin to use three-way hedges.
Among its peers in the MLP and LLC space, LINN by far hedges the most production. BreitBurn Energy Partners (BBEPQ), for example, has hedged roughly 75% of its production through 2015, whereas LINN is 100% hedged through 2016. BreitBurn almost exclusively uses swaps as its hedge of choice. It's a similar story at Vanguard Natural Resources (NYSE: VNR), which also uses swaps to almost exclusively hedge natural gas while using three-way collars to hedge about a third of its oil production. While LINN could get more creative, one thing I'd be surprised to hear is that it's going to join these two peers and leave some of its production unhedged.
As far as the actual numbers go, LINN provided its first-quarter and full-year guidance last quarter so we have some numbers to keep an eye on. First, the company expects oil and gas production to be between 810 MMcf per day and 845 MMcf per day for the quarter. The company expects that this production will generate $372 million in adjusted EBITDA for the quarter.
After interest and maintenance capital, LINN expects that its production will leave it with distributable cash flow of $165 million. That should translate into distributable cash flow per unit of $0.70 which would imply a coverage ratio of less than one times. While that's a lot less than is preferred, LINN expects that the Berry deal will enable it to have a much safer 1.2 times coverage ratio, even after its planned distribution increase, so there are no red flags here. Keep an eye on these numbers because if LINN can't meet them it could signal that there's a problem.
The Foolish bottom line
I expect LINN's first-quarter report to at least be in line, if not a slight beat, and I'm fairly confident that the company will alleviate any residual concerns that investors have following all the recent comments by short sellers. I'd also look for word about the future of its distribution with the possibility of an announcement of moving to monthly payouts. Finally, I wouldn't put it past the company to announce a small asset acquisition; it does have a little extra capital after recently making a return.