What Makes Linn Our Top Energy Pick

Mar.11.14 | About: Linn Energy, (LINEQ)

Summary

Linn has just announced solid fourth-quarter results.

Recently-acquired Berry contributed 44 MMcfe/d during the fourth quarter and 11MMcfe/d to the total average production level per day during 2013.

A fundamental review reveals that the shares have upside potential at this level.

Recently, Linn Energy (LINE) announced its fourth-quarter earnings, in which it stated that it has managed to increase production by 11% to an average of 889 MMcfe/d during the fourth quarter (compared with the same quarter of 2012), while the annual increase was 23%, leading to an average of 822 MMcfe/d for the whole of 2013. Both these amounts include production from the addition of Berry Co. Berry contributed 44 MMcfe/d during the fourth quarter and 11MMcfe/d to the total average production level per day during 2013. This shows that excluding Berry's contribution, Linn Energy itself managed to increase its production by almost 21% year-over-year.

Linn has managed to close the quarter with production levels near its guidance of between 840 MMcfe/d and 860 MMcfe/d, which was reduced from the previous guidance due to severe winters that affected the entire oil and gas production industry. Moreover, Linn reported that Q1 2014's expected production will be between 1,070 MMcfe/d and 1,100 MMcfe/d, which is lower than our estimate. Berry had an estimate of 44,000 Boe/d during the fourth quarter 2013, which is equal to 264 MMcfe/d, and by adding this to Linn's fourth-quarter production of 845 MMcfe/d, we end up with 1109 MMcfe/d, which is close to the high-end expected production for Q1 2014. We believe that the low expected production levels for the first quarter of 2014 might have been due to the severe winter that started at the end of 2013 and continued till the first month of 2014. This may have affected production at the start of 2014, just as it did in the fourth quarter of 2013.

If we look at the current price fluctuation in oil and natural gas, we can see that there has been a jump in both due to tensions over the Ukraine crisis. WTI Crude Oil price jumped by 6% during Feb 2014 alone, and has now eased somewhat after Putin's intentions over military action. Putin's announcement that military action would be a last resort increased investor confidence, resulting in positivity in the equity market and a slight decline in commodity prices. Moreover, natural gas prices were touching the ceiling during extreme cold due to a higher-than-usual demand for natural gas. The reason for mentioning the fluctuation is that Linn Energy hedges 100% of its production over four to five years, which safeguards against declining commodity prices, but also eliminates the opportunity to exploit short-term high prices due to seasonal or political factors.

Linn Energy also made it clear that it intends to decrease its capital budget from $1.8 billion in 2013 to $1.6 billion. While this might have raised the eyebrows of some investors, we believe that the company has the luxury to decrease its capital expenditure, as it has recently made an addition to its reserves. The reserves have reached 1.1 billion barrels of oil equivalent of proven reserves and around 264 MMcfe/d of production per quarter based on the most recent quarter.

Analysis

The company paid a dividend of $2.90 per share last year, giving a yield of 9.1%, which is very high compared to the industry average. Furthermore, operating cash flow (OCF) yield supports that the company has the capacity to maintain such a high level of dividend payout. According to our estimates, the OCF yield is around 11%, which is higher than the dividend yield of 9%.

Company

Industry

Sector

Dividend Yield

9.10

1.88

4.38

Click to enlarge

Source: Reuters

Amounts in ($ Billions)

Market Capital

10.50

Long-term Debt

8.96

Cash and Cash equivalents

(0.05)

Enterprise Value

19.41

Click to enlarge

Source: Yahoo! Finance

According to our calculation, the Enterprise Value of Linn Energy is approx. $19.4 billion, from which we find the target price to be $58.87 per share. Currently, the share is being traded at around $31, which shows huge potential in the stock, as it is currently being sold at a discount of roughly 46%. Furthermore, the fundamentals discussed above also support the fact that the company is still worth buying and can give good returns to the investor in the form of high dividends and capital appreciation.

For our detailed take on Linn, click here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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. Equity Flux is a team of analysts. This article was written by our Basic Material analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.