After the bell on Tuesday, Linn Energy (LINE) (and by extension sister company Linnco (LNCO)) boosted fourth quarter guidance despite the bad weather that hit Texas (full release available here). The company now expects daily production of 840 MMcfe to 860 MMcfe compared to an earlier forecast of 850 MMcfe. Essentially, management is keeping the same midpoint but providing a little wiggle room. Given the recent storm that hit the Permian Basin, there had been expectations for lower production. As a consequence, it is certainly good news that Linn is maintaining the midpoint while leaving the door open to an upside surprise.
More impressively, management is boosting its metric of distributable cash flow now clumsily (thanks SEC!) called "excess (shortfall) of net cash provided by (used in) operating activities after distributions to unitholders and discretionary adjustments considered by the Board of Directors" to be 5-10% above its current monthly payout of $0.2416. Management had previously expected it to be equal to the distribution, so management is boosting its cash flow metric by a significant 5-10%. After what has undoubtedly been a rough year, this is a solid fourth quarter forecast that lends significant credibility to the sustainability of its payout.
If management is able to execute on the Berry (BRY) assets as it expects to (which is an open question after raising its bid), there should be further 5-10% upside in its distribution in 2014. If it turns out that Linn is overpaying for Berry, then distribution growth will disappoint to investors. LINE got a solid endorsement when ISS urged shareholders to vote in favor of the deal. While the Berry deal is unlikely to prove to be the deal of the century, the preponderance of evidence suggests it will be moderately accretive to unitholders.
My only qualm with the updated guidance is the continued emphasis by management on nominal production growth, which will be 8-10% in 2013. On the face of it, 8-10% growth appears outstanding. However, investors do need to normalize production growth for dilution. In the first nine months of 2013, Linn has increased its unit count by 2.2% and added $480 million in debt. Production is growing at Linn in part because the company continues to buy assets, so organic growth (or growth per existing unit) is lower than headline growth. If you normalize for these factors, effective growth is the 5-7% range.
This growth rate is still solid and good enough for investors to do well owning LINE or LNCO; however by focusing on nominal growth, a rosier picture can be given. Next year with the integration of Berry's assets, nominal production at LINE will obviously rise dramatically, so I hope management will be transparent in providing investors with pro forma growth figures as transparency is never a bad thing. Investors should just recognize that the boost in effective production is less than headline figures due to dilution and the assumption of debt.
This guidance update was definitely good news for investors in Linn Energy who should feel far more confident in the current distribution and look for a moderate increase in 2014. At $30, Linn shares will provide investors with some nice income with the potential for 10% upside. However given the recent rally, investors may want to look at other upstream MLPs with higher yields that now trade at a discount to Linn like Atlas Resource Partners (NYSE:ARP), which yield 11%. Investors should do fine in Linn, but I think there are better buys elsewhere in the MLP space.
Disclosure: I am long ARP. 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.