Oversold Linn Energy/Linn Co Could Rally On The Fiscal Cliff Deal

| About: Linn Energy, (LINEQ)

On January 1, 2013, the US Congress voted to approve a "fiscal cliff" avoidance bill. This is not good news for the long-term health of the US Budget Deficit. However, it is good news short-term for the US economy and the US equity markets. It means there will be only slightly less spending by the federal government. It means the Bush tax cuts will still apply for families making under $450,000 per year. The payroll tax cut will disappear though; and the $109B in planned cuts to domestic and military programs will only be put off for two months. The CBO said the bill would increase US budget deficits by nearly $4T over the next 10 years. This means it is not a solution. It means further cuts will have to be made. However, more people are starting to realize that the major entitlement programs cannot remain inviolate. Cuts can be made to these (and should be) without serious negative impact to the US economy in the near term (or even later). If the qualification ages are raised, people will work until an older age. This could well actually help the US economy instead of hurting it.

Linn Co (LNCO) is essentially a shell company that owns units/shares of Linn Energy (LINE). Its main raison d'etre is to convert LINE's MLP distributions from ordinary income status to "dividend" status. If you want to receive ordinary dividends, you probably want to own LINE through LNCO. For those families making less than $450,000 per year, owning LNCO could mean a significant savings.

Linn Energy is an oil and gas E&P MLP. It pays a hefty 7.86% dividend. It IPO'd in 2006. Since then it has performed spectacularly well. Its stock alone has appreciated approximately 99% (as of October 30, 2012). If you add in the dividend payments during that period, the total return has been approximately 260%. By contrast the S&P 500 TR Index is up only about 13% during the same period (again as of October 30, 2012). LINE has been a great retirement income stock, and it seems likely to continue its great record. LINE buys already developed properties about which there is little doubt as to productivity. It continues production, and it develops further resources on the already significantly proved fields. Amounts LINE spent on acquisitions in recent years were $1.37B in 2010, $1.51B in 2011, and $2.80B in 2012. LINE has approximately 5.1Tcfe in total proved reserves. 64% of the reserves are proved developed, 45% of the reserves are oil, and 55% of reserves are natural gas. It has an approximate 17 year reserve-life index. It has more than 15,000 gross productive oil and natural gas wells. Plus it is not buying new properties from fly by night companies. Recent acquisitions have been from the likes of BP America (NYSE:BP), Plains Exploration (NYSE:PXP), Southwestern Energy (NYSE:SWN), and Anadarko Petroleum (NYSE:APC). The chart below shows LINE's acquisition growth and its planned potential organic growth over the next few years.

We will see the exact figures for Q4 2012 when LINE reports earnings on February 18, 2012. LINE is/was planning to roughly double production from 425 MCFE/d at the end of 2011 to about 825 MCFE/d at the end of 2012. It has likely achieved this goal. It may have exceeded it. One of its big new success stories has been the Hogshooter play in the Granite Wash. By October 30, 2012, LINE had completed 12 Hogshooter wells. These had $1.2B of approximately 2110 bopd, 528bpd of NGLs, and 3.4 Mcf/d of natural gas per well. LINE's plan was to drill another 11 Hogshooter wells in Q4 2012. With these kinds of results, LINE seems likely to report better than expected results for Q4 2012. LINE controls about 95,000 net acres in the Granite Wash, which is the area that contains the Hogshooter. LINE's first three Hogshooter wells paid for themselves within the first 90 days. That's incredibly economic!

The Hogshooter is by no means the only development play of LINE. It is strongly oil weighted. Therefore, LINE has been pursuing it actively in this time of low natural gas prices. LINE has a large inventory of low risk and liquids-rich development (drilling) opportunities. These include:

  • Jonah Field -- about 650 locations.
  • Granite Wash -- about 600 horizontal locations
  • Wolfberry -- about 400 locations
  • Bakken -- about 800 horizontal locations
  • Cleveland -- about 165 horizontal locations
  • Kansas Hugoton -- about 800 locations
  • Salt Creek Field -- CO2 flooding opportunities.

This sizable inventory of development opportunities should last LINE for some time into the future. LINE's recent LNCO IPO raised about $1.2B, and demand for LNCO has continued to be strong. This should put LINE in a better financial position to expand further in 2013 and beyond.

The following charts give a good assessment of LINE's growth history.

The above charts speak for themselves about LINE's growth. For those who worry that this growth does not carry over into per unit growth, the annualized distribution per unit chart above shows that LINE has managed growth per unit of about 81% since Q2 2006.

On top of the above strength, LINE is 100% hedged in both oil (through 2016) and natural gas (through 2017) production. This should allow it to weather any new slowdown or recession. Its one weakness is that it has no NGLs hedging. When NGL prices fell by approximately 38% in Q2 2012 alone, this resulted in a 0.18 times reduction in LINE's distribution ratio to 0.97x for Q2 2012. Since that time, NGL prices have rebounded a bit, and they seem likely to rebound further with an el Nino winter forecast for 2012-2013 in the US. The distribution ratio of 1.40x for Q3 2012 reflects this improvement. The recent US Congressional fiscal cliff deal should help too.

The idea of Linn Co. was a good one. It should give LINE an advantage over its competitors with respect to raising funds for new acquisitions. With a possible recession coming in 2013, there are bound to be some great properties available at bargain basement prices. If LINE can take advantage of this, its unit holders and LNCO's shareholders are all likely to benefit. This should give LINE (7.86% dividend) an advantage over its competitors such as: BreitBurn Energy Partners (BBEP) -- 10.07% dividend, Vanguard Natural Resources (NYSE:VNR) -- 9.35% dividend, and Penn West Petroleum (NYSE:PWE) -- a Canadian company with foreign tax issues and a 10.04% dividend. These companies don't have LINE's new Hogshooter results. However, they too may be technically set to rebound along with LINE, so investors may want to take a good look at these stocks too.

The five-year chart of LINE provides some technical direction for this trade.

The slow stochastic sub chart shows that LINE is greatly oversold. The main chart shows that LINE has been in an overall consolidation pattern since the second half of 2010. LINE's price is currently at the bottom of that range. Logic says it should bounce upward in the near term, especially given the recent Hogshooter results. Further the Q4 results seem likely to exceed estimates. This should mean LINE is a Buy. The average analysts' recommendation is 1.8 (a buy). The CAPS rating is five stars. The FPE of 19.58 is quite reasonable for this kind of stock, especially with the great recent Hogshooter results and LINE's 100% hedging on both oil and natural gas production for many years into the future.

Even with the partial deal on the fiscal cliff, the US is likely heading for a slowdown or even a recession in 2013. This may mean LINE's stock price could fall. It fell to $11.20 on December 1, 2008 in the last recession. Of course, that was relatively soon after its IPO; and LINE was a much smaller and weaker company then. A chartist would not expect LINE to fall much below $25 per share if a recession occurs in 2013. With this in mind you may want to average into LINE or LNCO over the next six months to one year. Then you will be sure to get a relatively good average entry price. More aggressive traders may wish to try to catch the likely short-term move up due to technicals, the fiscal cliff deal, the Hogshooter results, and the likely great Q4 results. LINE is supposed to report Q4 2012 earnings on February 18, 2013. Unfortunately, the US National Debt Limit extension debates will likely be going on then. They may put a damper on the US equity markets. Traders should keep this in mind.

Note: Some of the fundamental data above came from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LINE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.