Linn Energy (LINE) is one of the most interesting master limited partnerships today that is discussed widely on financial forums. Like other master limited partnerships, its appeal is in the form of a monthly dividend yielding north of 11% from its oil and gas operations. Further, most believe that the company will grow and also lead to capital appreciation, on top of the bountiful dividend. LINE's current holdings are impressive and likely can sustain revenues and dividends paid, though perhaps not as high as shareholders are accustomed without growth. The purpose of this article is to discuss what to expect from the earnings release schedule today, October 28th, for the third quarter 2013 after markets close. The press release that announced the earnings release schedule came this past Friday, October 25th, did not include however a scheduled quarterly conference call with analysts. This has had many investors on edge and the lack of clarity has resulted in all sorts of discussion about what could be in this release. There are lots of things investors could look for in the release, but as I have responded to several inquiries from followers on the matter, I thought I would highlight them here.
I will be looking for the key metrics of LINE that were reported in the second quarter 2013. First and foremost I want to see the revenues. Last quarter, revenues totaled $839 million, which did include non-cash changes in fair value of commodity derivatives of $271 million, and including the reduction of put option premium value over time. This led to a net income of $1.47 per unit for the second quarter 2012, which consisted of $1.15 per unit of non-cash changes in fair value of commodity derivatives. Looking at the non-GAAP EBITDA for LINE in Q2, the company saw $362 million in earnings. What plays into the dividend is distributable cash flow. In Q2 2013, this metric was $0.65 per unit and thus based on dividends paid, the company netted at distribution coverage ratio of 0.89x. This is not sustainable long-term. While the quarter was challenging, the company did acknowledge that things were improving late in the second quarter into the third quarter. Thus, I am looking for an improving quarter and suspect LINE will deliver.
Their hedging practices have been the subject of inquiries and reviews. That said, they perform well. During the second quarter 2013, LINN's hedged realized average price for natural gas was $5.24 per Mcf. This is $1.12 per Mcf more than its unhedged realized average price of $4.12 per Mcf. The Company's hedged realized average price for oil was $93.49 per Bbl. This is $2.22 per Bbl more than its unhedged realized average price of $91.27 per Bbl. Realized average price for NGL production was $26.69 per Bbl for the second quarter 2013. I expect that their hedging practice delivered comparable differences in the third quarter, adjusted for different prices.
Lease, Transportation, Taxes and Other Expenses
These expenses directly impact revenue and distributable cash flow. While there is no true way to predict where these will go, they are important to keep an eye on. Lease operating expenses for the second quarter 2013 were approximately $84 million, or $1.18 per Mcfe, compared to $70 million, or $1.22 per Mcfe, for the second quarter 2012. Transportation expenses for the second quarter 2013 were approximately $29 million, or $0.41 per Mcfe, compared to $22 million, or $0.38 per Mcfe, for the second quarter 2012. Taxes, other than income taxes for the second quarter 2013 were approximately $32 million, or $0.46 per Mcfe, compared to $31 million, or $0.53 per Mcfe, for the second quarter 2012. General and administrative expenses for the second quarter 2013 were approximately $46 million, or $0.65 per Mcfe, compared to $41 million, or $0.72 per Mcfe, for the second quarter 2012. Depreciation, depletion and amortization expenses for the second quarter 2013 were approximately $199 million, or $2.80 per Mcfe, compared to $144 million, or $2.50 per Mcfe, for the second quarter 2012. For the most part, I expect little change, but these are large expenses and need to monitored over time for not just LINE, but all master limited partner ships
Commenting at the end of Q2, Mark E. Ellis, President and CEO stated:
"While challenges have made for a disappointing first half of 2013, we are optimistic about the remainder of the year and expect to deliver annual production growth of 8%-10%"
This statement was a huge confidence builder for shareholders of LINE. The second quarter was plague with issues. Production volumes were negatively affected by poor capital performance, additional ethane-rejection and continued infrastructure curtailments. Volumes from the Jonah Field were negatively impacted by ethane-rejection due to the depressed price of ethane. LINN estimates ethane-rejection in the Jonah Field reduced second quarter 2013 production volumes by approximately 6 MMcfe/d. Further, infrastructure curtailments in the Permian Basin resulted in lower than expected production volumes caused by shut-ins and high line pressures. On June 1, 2013, the previously announced Panther divestiture became effective, which also reduced second quarter 2013 results by approximately 7 MMcfe/d. Despite these issues, LINE "anticipates production to average approximately 820 MMcfe/d for the third quarter." Thus, I am looking for this important cutoff. Anything below this number is a big disappointment and will suggest there is ongoing production issues that must be addressed before I will jump back into the stock. A number above this benchmark will be a sign of health. If it is perfectly in line, then it is a kudos to management, as they really know their company.
I will not go into detail here, but I am looking for production updates and more development milestones for many of the properties, including the Permian Basin, Jonah Field, Hugaton Field and the Granite Wash. However, the most important part of this release, will be any commentary on the merger with Berry Petroleum (BRY)
Will LINE Have Anything to Say About BRY?
When BRY released their earnings, they commented a bit about the merger. BRY recently stated that the deal with LINE is the subject of an inquiry by the Securities and Exchange Commission and it will not be completed by October 31st. This means that after this date either BRY or LINE can decide not to proceed with the deal. Management of BRY said in a Securities and Exchange Commission filing:
"There can be no assurances as to whether the parties will agree to extend the end date or that the parties will refrain from exercising their rights to terminate the merger agreement ..."
We are now three days away from the October 31 "walk away" option date. If the deal falls through I think it is definitely a negative for LINE. It is strong on its own, but it does rely on acquisitions to continue growing. With BRY's assets, the deal is definitely critical to long-term growth. I believe the dividend really is dependent on continued growth. While the monthly policy gives LINE flexibility, without this deal it is likely to trend lower. For more on the potential significance of this deal, please see this recent article.
This release is important. Any commentary on the BRY acquisition will impact the stock and likely take precedence over operations and earnings. Still, these metrics are key. Should there be no acquisition, understanding where the company stands on meeting its production guidance, its expenses, its location specific performance and its distribution coverage will be key moving forward. I have no position in LINE, but am on the sidelines, waiting to get in. I believe the company is a good long-term position, but I also believe that we need clarity on the BRY deal before I am comfortable getting in. If the acquisition goes through, it will lead to a huge jump in oil production and assets for LINE. We must watch and listen closely to this release, and any subsequent earnings call.