Linn Energy (LINE) is one of the highest-yielding MLPs, with a distribution yield of over 10%. However, in the last year, the company changed its cash distribution pattern and divided the quarterly payments into small monthly payments. The unit performance of Linn Energy has been poor, and the stock has lost more than 18% during the last twelve months. Year-to-date, the unit has lost over 7%. Investors usually choose MLPs for the income component, as MLPs distribute more than 90% of the cash. However, after the fall in price over the last twelve months and the recent moves by the partnership; we believe Linn Energy might be ready to move higher over the next 12-18 months. Let's look at the issues and what the management should do to tackle these issues.
Distributable Cash Flows
Cash distributions and the cash distribution coverage is an essential metric when we analyze MLPS. The partnership paid $240 million in cash distributions to the unitholders, and its cash distribution coverage currently stands close to 1. Low cash flows coverage ratio will not allow the partnership to increase its cash distributions in the short term. However, the current distributions do not look under threat, as the available distributable cash flows should be enough to meet its cash distributions. The partnership would not want to cause another drop in the stock price with a reduction in distributions - if the distributable cash flows fall, the drop will not be big and it should be easily managed with borrowed funds. In the long term, we see considerable growth in cash flows if the management carries out its strategy properly, and the cash distributions should grow over the next few years.
Debt: An Issue?
Source: SEC Filings
The long-term debt of the partnership has grown at an average annual rate of 91%, far above the average annual growth rate of 56% in the total assets. The portion of debt maturing in the near term might represent another problem, as the partnership will have to take on new debt to pay the maturing debt, or sell some of the assets. Line will have to pay $0.8 million in the current year; $2.2 billion over the next two years, and a further $3 billion by 2018. The management of debt will be a key issue for the partnership - forward debt/EBITDA ratio is expected to be over 4 for Linn Energy - the management will have to enhance the balance sheet of the partnership in order to realize the benefit of increased production. The image below shows the upcoming debt obligations of the partnership.
Source: SEC Filings
Linn reported increased production in different segment of the business - the production growth for the full year is expected to be between 3-4% -- the growth figures are not hugely impressive; however, it shows that there has been some progress. This production growth was led by the Uinta Basin in Utah and the North Midway-Sunset in California - both these locations are from former Berry properties and are already optimized to the full capacity. Production growth figures will need to improve in order for the partnership to make a solid move further.
Assets with Potential
Linn Energy's asset base has a reserves life index of approximately 16 years. The partnership owned a total of 19,810 gross and 14,068 net oil and natural gas wells in the region, with 3,154 proved but developed drilling locations, which will increase the operational throughput of the partnership over the next few years. The highest-yielding areas in the last year included the Midcontinent region, with 330 MMcfe/d of output, and showed a growth of 5% compared to the last year. Moreover, the Rockies region showed 105% growth in the last year, which is mainly due to the Berry Petroleum merger with the partnership. Nonetheless, Linn Energy also managed to reduce its drilling and exploration costs by 20% over the last year, thus increasing its efficiency and profitability in the long run.
The first-quarter results also proved to add a decent value of 1,104 MMcfe/d in the operational yield. The uptrend is mainly due to the increased yields in the Rockies, California, and Permian Basin operations. The Permian Basin has increased its yield by 108% compared to the same period last year, making it the third-largest contributor to the company's portfolio. Moreover, the Wolfcamp region offers a great opportunity to create substantial value for the partnership, with acreage of 55,000 net acres in the region.
The partnership is currently looking to offload its Permian Basin assets - the management disclosed that it would prefer an asset swap for its assets, and is also looking forward to perform cash sale of the Permian acreage. The partnership's assets might be worth around $2 billion, based on the deal in the Midland Basin by Athlon Energy (NYSE:ATHL) - cash will go a long way in enhancing the balance sheet of the partnership. However, if the partnership is able to swap the assets for mature property, then we might see sustained long-term growth in cash flows.
We believe that the downside to Linn Energy is limited, and the risk-reward is currently very attractive due to the recent fall in the stock price. The management is making efforts to grow production, which should result in increased cash flows if the commodity prices remain high. Furthermore, the assets sale efforts will allow the partnership to enhance its balance sheet and decrease leverage - as a result, Linn will be able to truly benefit from the increased production. In the short term, we believe the distributions are safe, and it should grow in the long term. At current price levels, we believe Linn Energy is a good investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.