Linn Energy: High Dividend, Low Valuation

If you're an income investor looking for the best stocks to buy, Linn Energy (LINE) may be one of those dividend paying stocks you should take a long look at.

Linn Energy's high dividend yield of over 11% is second only to Martin Midstream Partners in the Independent Oil & Gas group, an industry filled with dividend stocks.

However, when you look at Linn Energy's valuation figures compared to the rest of the indie gas and oil stocks, they appear to be undervalued:

Comparison Linn Energy vs. Indy Oil & Gas Industry

	LINN	INDUSTRY AVG.
Dividend Yield	11.2%	2.32%
P/E	1.55	12.95
P/Book	1.07	2.72
P/Sales	1.22	1.95
P/Free Cash Flow/share	1.47	7.93
ROE (TTM)	94.67	13.10
ROA (TTM)	36.89	5.37
ROI (TTM)	83.02	7.37
Dividend Growth Rate *	44%	18.94% (5 yrs.)

* (LINE's dividend growth rate is only measured over 3+ years, since their Q1 2006 IPO).

Linn's debt leverage ratio comparisons are also solid:

• 2.45% Quick Ratio, vs. the industry's .95%.
• .62 Long Term Debt/Equity is below Industry Median of .72, but higher than industry .46 average

They increased their dividend distribution coverage to 1.21 in Q2, (bringing their dividend payout ratio to 81%), and also brought down their lease operating expenses to $1.67, as compared to their mid-point guidance.

In the company's Aug. 6th earnings release, Michael C. Linn, Chairman and CEO, stated, "The Company improved its financial strength through our renegotiated credit facility, bond and equity offerings and repositioned hedge book. Additionally, we recently announced two asset acquisitions in the Permian Basin, and we are excited about the potential to grow this into a core area for the Company. With the steps we have taken thus far, we believe that the Company is poised to continue to deliver positive results and to grow through additional acquisition opportunities.

The Company also announced that it had entered into two definitive purchase agreements to acquire certain oil and natural gas properties located in the Permian Basin in West Texas and New Mexico for a combined contract price of $118 million, and anticipates that both acquisitions will close before October 1, 2009, and will be financed with borrowings under LINN Energy's existing credit facility. These properties are expected to have proved reserves of more than 12 million barrels of oil equivalent, which are approximately 86 percent oil and more than 58 percent proved developed. These assets are currently producing approximately 1,350 barrels of oil equivalent per day, resulting in a reserve life index of more than 24 years. The combined acquisitions offer approximately 180 proved infill development and low-risk optimization projects that the Company anticipates will create future growth opportunities. The acquisitions have not been incorporated into guidance as of yet.

Like many other stocks, LINE has run up considerably from its 52-week low, ($10.81), and recently hit a new high of $23.00, before declining slightly to today's $22.47 opening price. If you're looking for solid high dividend stocks, maybe you should add LINE to your best stocks watch list, and buy on the dips. Another strategy would be to sell puts against it, if you're feeling skeptical about the upcoming autumnal period, which is often a choppy one for stocks. The Jan. 2010 $20.00 put is currently bid at $1.00.

Disclosure: Author is long shares of LINE and short puts.

Comments

[A Barrel Full:]

Why are they undervalued? Is there a hidden risk?

Aug 14 06:26 AM

[Ranjit Thomas:]

The problem with LINE is that like a lot of other exploration companies, they generate no cash, pumping huge amounts into capex. The high dividend yield is illusory because it is funded by regular equity issuances - no different from a Ponzi scheme. Also, they were smart/lucky enough to hedge most of this year's production at high prices. As these hedges come off, they will be in deep trouble.

Aug 14 07:05 AM

[YoYoMama:]

There's no problem if you are strictly an income investor and not particularly interested in capital appreciation.

On Aug 14 07:05 AM Ranjit Thomas wrote:

> The problem with LINE is that like a lot of other exploration companies,
> they generate no cash, pumping huge amounts into capex. The high
> dividend yield is illusory because it is funded by regular equity
> issuances - no different from a Ponzi scheme. Also, they were smart/lucky
> enough to hedge most of this year's production at high prices. As
> these hedges come off, they will be in deep trouble.

Aug 14 08:44 AM

[Mmarrkk:]

Ranjit: I think if you would look a bit further you'd see that they not only have this year's production hedged, but they also have 2010 and a large portion of 2011 hedged at very nice prices. Luck? well...

And LINE is not just an exploration company, they are a production company and are generating a lot of income. Look at their free cashflow, a great measure to evaluate these funds by.

Also, look at their growth in reserves.


On Aug 14 07:05 AM Ranjit Thomas wrote:

> The problem with LINE is that like a lot of other exploration companies,
> they generate no cash, pumping huge amounts into capex. The high
> dividend yield is illusory because it is funded by regular equity
> issuances - no different from a Ponzi scheme. Also, they were smart/lucky
> enough to hedge most of this year's production at high prices. As
> these hedges come off, they will be in deep trouble.

Aug 14 09:59 AM

[WhoisJohnGalt:]

Finally, someone points out this MLP! The big thing to note for valuation sake is the low P/E ratio to the industry. For short-term dividend accumulation to generate large annualized gains, LINN is a solid choice. The "Ponzi Scheme" seems questionable seeing as how they have consistently retired equity up until last quarter. And yes, in that same time span they have generated positive FCF to stave off problems of investor payout.

Aug 14 10:13 AM

[mplaut:]

Line is not an exploration company. They own well-established producing properties with long production lives. That is also the only type of property they buy.

Aug 14 11:47 AM

[zorro6204:]

I got news for you, they're hardly alone. The same comments apply to CPNO, ENP, EVEP, LCGY, MWE, NGLS, PSE, VNR and WPZ, all yielding in the 10-15% range, and all financially strong, especially with recent equity offerings.

Aug 14 12:44 PM

[losbronces:]

Ranjit has made some very serious and very false claims about Linn Energy, LLC.

Lynn Energy, LLC is a producing company, not an exploration company. The majority of the revenues come from natural gas and natural gas liquids, which are well hedged. Oil accounts for approximately 30% of the reserves (oil is also hedged).

The distributions (it is an MLP) come from free cash flow, not new shares issued. New shares are sold primarily to raise capital for acquisitions or to pay down credit facilities. The acquisitions in turn generate revenue. Linn also uses credit and operating cash flow for acquisitions.

You can use this link to see the various presentations that Linn Energy has made that explain the current hedges that they have in place: phx.corporate-ir.net/p.... If the link doesn't work, go the Linn Energy LLC website where all of these presentations are available along with financial statements.

Of course, the current results at Linn are heavily influenced by the hedges that they have in place. If energy prices, especially natural gas, remain low beyond 2012, then distributions may have to be reduced.

I personally don't see much potential for short-term capital appreciation as I don't see energy prices raising above the current floors established by Linn's ; however this company has been touted by Jim Cramer which has brought it from a trading range of $14 to $16 per share to the current trading range.

As I previously stated, Linn Energy is set up as an MLP, so some of the distribution is classified as a return of capital and individual investors also get to take the depletion allowance. This should result in paying lower taxes on the distributions than on C Corporation (such as Exxon Mobil) dividends for most individuals.

I also don't see Linn being "in deep trouble" as intimated by Ranjit when the hedges come off. Of course, it should be obvious to all that Ranjit did no research on this company whatsoever.

On Aug 14 07:05 AM Ranjit Thomas wrote:

> The problem with LINE is that like a lot of other exploration companies,
> they generate no cash, pumping huge amounts into capex. The high
> dividend yield is illusory because it is funded by regular equity
> issuances - no different from a Ponzi scheme. Also, they were smart/lucky
> enough to hedge most of this year's production at high prices. As
> these hedges come off, they will be in deep trouble.

Aug 14 01:14 PM

[whidbey:]

Too much natural gas. I am still nursing HGT and hope that Obama energy policy will default to NG for power generation this fall. BUT KWH have declined. We may be running out a need for energy soon.

Aug 14 01:29 PM

[Mmarrkk:]

Whidbey: Agree we have too much nat gas in the overall U.S. and Canada system. However, LINE has 100% of their gas hedged through 2011. So they aren't even exposed to gas prices until 2012. Gives a lot of time for prices to recover which I think they will.

I wish Ranjit's erroneous and slanderous post would cause the price to plummet...so I could buy some more cheap cheap shares! Put this one in the account and cash checks!

Aug 14 03:40 PM

[Alan von Al...:]

I'd feel much better about Linn if he disclosed who the seller was, where the assets are in 'the Permian Basin' (a pretty big area), and who advised or brokered the deal.

Aug 18 01:16 AM

[Alan von Al...:]

On Aug 14 09:59 AM Mmarrkk wrote:
> LINE is not just an exploration company, they are a production
> company and are generating a lot of income...

Mmarrkk, afaik, Linn doesn't do any exploration, never has.

Aug 18 01:20 AM

[wcl:]

Looking forward, the LINN Energy is approximately 100% hedged for 2009, 2010 and 2011. In 2009, it is hedged at weighted average prices of $102.21 per barrel and $8.32 per thousand cubic feet of natural gas (Mcf).

My question: Is the above the hidden danger of LINN? What happens if the "Hedges" are in the wrong direction?

Bill

On Aug 14 06:26 AM A Barrel Full wrote:

> Why are they undervalued? Is there a hidden risk?

Aug 18 11:54 AM