Linn Energy (LINE) is down over 2% early Thursday morning as investors digest relatively disappointing quarterly results (press release available here). It is important to remember that towards the end of the quarter Linn completed its long awaited acquisition for Berry Petroleum, so there are a lot of moving parts that are important to consider when evaluating the results and the guidance. After looking through these results, I think investors must subdue their hopes for a distribution increase in the near term, and I would not rush into LINE at current levels. Investors should also note this analysis applies to LinnCo (LNCO), a corporation that solely owns units of LINE.
In the quarter, Linn Energy grew production by 11% to 889 MMcfe/d. However, if you strip out Berry, production was only up 5.5% to 845 MMcfe/d. This figure is obviously impressive, and while it was within the previous guidance range, many were hoping for a figure of 850 MMcfe/d or higher. Linn also suggested that bad weather made it more challenging to drill. Total revenue also jumped about 10% and was roughly in-line with estimates at $629 million. $585 million of that came from the sale of oil, natural gas, and NGL.
Investors mostly invest in an MLP for its distribution, so when quarterly numbers come out, it is important to consider how well the company covered its payout. In the quarter, the distribution totaled roughly $170.5 million (an annual payout pace of $2.90). Linn generated cash in excess of the distribution of $31.5 million. In other words, Linn paid out $31.5 million less than it could have. This typically is a great sign as it implies Linn could raise its distribution in the near future, though Linn has held the monthly payout constant so far in 2014.
Now as I said earlier, this quarter was complicated by the Berry deal. Essentially, Linn got the cash Berry generated during the quarter but did not have to make distributions to former Berry holders. Thanks to the Berry deal, the unit count has increased by about 94 million units. These units did not get distributions during the fourth quarter, but are now receiving distributions. These units get about $68 million per quarter at the current distribution pace, which doubles the excess cash reported in the fourth quarter. At the current pace of operations, Linn would actually have a cash shortfall of $36.5 million every quarter, which would endanger the distribution.
Now, Linn is forecasting increased production in 2014 of 1070-1140 MMCFE/d, which suggest 34% growth above 2013 production. Thanks mainly to the Berry acquisition, the unit count in 2013 increased by 40%. In other words, production per unit will likely decline in 2014, which will make it more difficult to raise the distribution in the near future. Moreover because Linn hedges out price risk, it is unlikely to garner much benefit this year from the recent spike in natural gas prices.
Linn Energy also touted a 34% increase in proved reserves to 6.4 Tcfe thanks to the Berry deal, though again that increase is less than the increase in the unit count. Reserves/unit is also lower year over year. This means Linn will have a tougher time increasing cash flow per unit over the longer term unless its unproved reserves eventually become very productive, which is uncertain.
Interestingly, Linn is budgeting cap-ex of $1.6 billion in 2014, which is lower than last year's $1.8 billion. I am pleased to see this sequential decline in cap-ex as it shows some discipline from management. Some analysts like Hedgeye's Kevin Kaiser have questioned the efficacy of this budget, and Linn is focusing more on predictable projects. I hope Linn maintains this level of capital discipline going forward as it works through its new Berry assets.
Overall, this quarter was unspectacular with organic production mildly disappointing. Further if you factor in newly issued units to Berry holders, there would be no excess cash in the quarter. In 2014, production/unit and reserves/unit will be lower than 2013 levels, which will put further pressure on the distribution. Linn has to do serious work to make its Berry acquisition an accretive one, and it may put a near term drag on per unit results. To sustainably increase the distribution, Linn will need to exceed the top end of its 2014 production guidance. With little distribution growth in the near future, I would not be a buyer of LINE until it trades back below $30 or LNCO falls below $28.50.