Linn Energy is hedged through 2011 - ensuring cash flow and payouts to investors.
“Our current feature, Linn Energy LLC (LINE 15.59 NasdaqGS), is an independent oil and gas play focused on the development and acquisition of long life properties, which complement its asset profiles in producing basins within the U.S., says George Southerland (Special Investment Situations, 423-886-1628, 12 issues, 1/14/09). “Structured as a tax-advantaged master limited partnership (you will use a special tax form), the astute, conservative management emphasizes yield generation over sexy, new discoveries. Acquisition and drilling activities are concentrated on mature fields with ample reserves but no longer producing at the high levels desired by the majors or aggressive exploration companies, CEO Michael Linn says, ‘We’re looking for bunt singles and not home runs.’ Production fields have typically 20-30 year lives and experience slow annual production declines. Production, though, is often boosted through reworking old bore holes, pumping equipment, water injection systems and lifts and LINE has nearly a 100% success rate when it drills.
The company pays out 60%-70% of its quarterly cash flow to its shareholders in distributions. The current indicated rate is $0.63 per quarter or a whopping $2.52 annualized for 16.20% yield. The shares are down 40% since June in concert with the collapse in natural gas/oil markets, as well as concerns by investors that the payouts could soon shrink resulting from weak energy prices. Also will frozen capital markets hamper LINE with its growth-through-acquisition policy? But such concerns appear unfounded. CEO Linn notes that even with no new acquisitions, the company can maintain production levels, and thus distributions, flat or modestly rising via workovers and drilling additional wells on its existing acreage. LINE has identified 4,100 low-risk drilling locations that can boost production on owned properties. ‘That’s about 15 years worth of drilling at our current pace, or 200- 300 wells a year,’ he says. ‘We could keep our production going at current levels with just 150 new wells a year.’ Analyst Richard Roy with Citigroup concurs. He believes the distribution level is ‘relatively secure’ for at least the next two years or more even without acquisitions and has a one-year $22 target on the shares. RBC Capital is even more enthusiastic with a $27 target.
“As for financials, management has been highly opportunistic. Taking advantage of the oil and gas speculative frenzy last summer, LINE sold-off three different properties, raising roughly $1 billion. The properties, though deemed promising, carried development expenses beyond the company’s generally accepted parameters. After reducing debt via the proceeds, LINE now has some $500 million of borrowing capacity under its credit facility, and that doesn’t include $100 million set aside for potential stock repurchases. Thus, liquidity is greatly improved. Management also comments that it will be able to cover all of its capital spending and unit distributions this year from internally generated cash flow. And by the way, it seems certain that lenders will loosen their purse strings on the inevitable recovery of oil and gas prices. A critical factor with LINE is its highly astute hedging program. The company locks in profit margins on a higher percent of its future production than its competitors, and also hedges production for more years into the future than most rivals. Futures markets and the commercial swap market are used to lock in set prices on forward sales for about 60% of production, while put option purchases comprise the bulk of the remaining hedges. The strategy proved absolutely brilliant as gas prices slipped to $5.50 coupled with the dive in crude oil to under $40. At current production levels, the company is 100% hedged for 2009, 2010 and 2011. For 2009, natural gas is hedged at a weighted average of $8.32 per MCF and oil and NGL production at $102.21 per barrel. For 2010, gas is hedged at $8.05 per MCF with oil at $99.68 per barrel. And, in 2011, gas is at $8.06 per MCF with oil at $77.00 per barrel. All in all, LINE has hedges on natural gas production for the next four years and oil and NGL production hedged for the next six years. This helps ensure cash flow and payouts for conservative investors.
“At 9-30-08, current assets were $386.00 million versus current liabilities of $218.10 million for a 1.8 current ratio. Total assets were $4.1 billion (including $3.6 billion in oil and gas properties) with unitholders’ equity $1.95 billion $17.12 per unit. LT debt totaled $1.8 billion. With the shares in the mid-$20s, Linn Energy offered primary appeal to those nearing retirement and seeking an attractive yield. But with the commodity crush, we now have some decent capital gains potential, not to mention the widened yield. Thus, LINE is transformed into a promising total return candidate. We are really impressed by the strong management team. They run a tight ship. We’re targeting the shares at $27 (a combination of dividends and capital appreciation) over 24 months for 75% upside. Set buy limits at $17 and pick up shares on dips. No mental stop.”
Joseph Parnes, Shortex
