For the second time this year, Barron's magazine this weekend has a negative article out about Linn Energy LLC (LINE) and LinnCo (LNCO). The article a few months ago was mainly concerned with the way Linn recorded certain derivative contracts it uses to hedge production. The piece was ill-timed for Barron's, being published February 18, a mere three days before Linn and LinnCo announced a $4.3 billion takeover of Berry Petroleum (BRY), which will add a large amount of oil exposure, and that Linn projects will increase DCF per share by $0.40 per year in the first year after closing. The Berry announcement gave the stock a nice pop, recovering the losses from the negative headline of the first Barron's article.
This weekend's article states that Linn's production was down slightly quarter over quarter, and that the company does not expect improvement in production until the second half of 2013. It also questions whether or not Linn can cover its distribution going forward, due to a very low projected coverage ratio without the Berry acquisition, and because the Q1 DCF was only $0.64, vs. a distribution paid by Linn of $0.725. There is another explanation of how Linn accounts for its derivatives as capital costs and investments, and depreciates them overtime, as well as some negative quotes from hedge fund managers. There are also some pretty useless comparisons to E&P companies in terms of EBITDA, and some wacky projections of value from the hedge funds and the company, with per share figures ranging from $5.58 to $64.74.
Barron's also makes a point to mention the strong retail support for Linn, which is Wall Street code for saying that individual investors, like myself and most people reading this, are the main owners of Linn units. It claims retail investors think Linn is just like pipeline MLPs, which are very stable, and that because Linn is an energy producer, it is much riskier. While I agree that Linn is more risky than some of my favorite pipeline MLPs, the fact Linn hedges the majority of its production over several years helps reduce the exposure to swings in commodity prices, and thus takes that risk off the table. Therefore, over the long term, the risk is that commodity prices are much lower when Linn's hedges roll off, which shouldn't be a concern until 2018.
As I have stated previously, the metrics I choose to look at for valuing partnerships are distribution growth and DCF coverage. Linn has been growing the distribution every few quarters since being stable from Q4 2007 to Q2 2010, and the Berry acquisition is projected to allow the distribution to grow again. However, distribution coverage by the company is forecast to be 1.02x in 2013 (based on a $2.99 distribution this year according to the Q1 report, 1.13x and 1.18x for 2014 and 2015, although those numbers assumed a $2.90 distribution at the time. These figures also assume no acquisitions, which is unlikely, given Linn's history. The growth rate of the distributions, and the coverage ratio, are both lower than I would prefer. Distribution growth is slower than that which investors can receive in other partnerships, and the low distribution coverage gives me little hope of steady increases over the years. That is not to say that Linn will not increase its distributions, as I expect it to continue to acquire properties, raising the distribution each time a large acquisition closes. However, as Linn gets larger, the acquisitions it must do to raise distributions need to be increasingly large, adding another layer of risk to the name.
To sum up, I think Barron's is exaggerating the risks to owning Linn Energy, as the company does not look like it will be cutting the distribution anytime soon, as the article hints at. However, the growth prospects of the distribution do not particularly excite me, as the distribution coverage is low and does not allow for much room to raise the distribution. I wouldn't sell Linn based on anything Barron's has to say, but investors in Linn should keep a close eye on both the production numbers out of Linn, and the distribution coverage ratio.
Disclosure: 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.
Additional disclosure: I submitted this article Sunday night, with no position in LINE. However, due to large drop Monday, I have taken a small long position via calls.