What Investors Should Make Of Linn Energy's Recent Portfolio Reshuffling

Aug.18.14 | About: LinnCo, LLC (LNCOQ)

Summary

Linn is betting big on the Hugoton Basin.

It's made significant acquisitions of some highly promising long-lived, low-decline assets.

Distributable cash flow should improve going forward, to better protect its huge distribution yield.

It's been a wild couple of years for exploration and production company Linn Energy (LINE), to say the least. Linn and its financial holding entity LinnCo (LNCO) have been under a great deal of scrutiny for everything ranging from its difficult takeover of Berry Petroleum, to its series of asset trades with companies like Exxon Mobil (NYSE:XOM) and Pioneer Resources (NYSE:PXD).

At its core, Linn's fundamental desire is to protect its huge distribution, which stands at 9.3%. This is a significant cash burden, so it's up to management to keep pursuing promising oil and gas fields to keep production strong enough to fund these distributions.

Here's what Linn has been up to lately, and its strategy to keep oil, gas and distributions all flowing.

Linn is betting big on the Hugoton Basin

With the deal for Berry finally in the rear-view mirror, investors should focus on the several moves the company has made recently to shake up its assets. Earlier this year, Linn made a deal with Exxon Mobil's subsidiary XTO Energy. Exxon Mobil received LINN's 25,000 net acres in the Midland Basin. From a production standpoint, Exxon Mobil obtained approximately 2,000 barrels of oil equivalents per day of current production, and LINN retained about 3,000 barrels of oil per day.

In return, LINN received a portion of ExxonMobil's interest in the Hugoton Field that stretches across Kansas and Oklahoma. This field, which is comprised of more than a half-million net acres and 2,300 operated wells, is currently producing roughly 85 MM cubic feet of equivalents per day. Of this production, 80% is natural gas and 20% is composed of natural gas liquids.

Total reserves are estimated to be approximately 700 billion cubic feet of equivalents, again, 80% of which are natural gas. Going forward, LINN has identified more than 400 future drilling locations, which will represent a good complement to LINN's existing Hugoton operations.

Linn's desire to increase its presence in the Hugoton area didn't stop there. Recently, Linn acquired approximately 235,000 net acres there from Pioneer Resources for $340 million. Current production is 40 MM cubic feet of equivalents per day. Total reserves are estimated at 340 billion cubic feet of equivalents.

Linn financed this deal through various sales of other producing and non-producing existing acreage in its portfolio. For example, Linn recently divested $90 million worth of assets in the Anadarko Basin.

Because of these deals, Linn will become the largest producer in the Hugoton field.

The over-arching strategy

LINN has long held the policy of seeking out mature, long-lived assets with steady, immediate cash flow. Essentially, LINN can't afford to waste time on speculative positions that may or may not pan out. It needs solid assets that currently produce. To that end, the recently acquired assets from both Exxon Mobil and Pioneer each have a shallow rate of decline of just 6%.

Protecting its distribution with enough cash flow has not always been a sure thing for Linn. Linn distributed $4 million more to investors last year than it brought in from operating cash flow. Recently, though, the trend has improved.

Linn fully covered its distribution and then some last quarter. The company generated $32 million of excess net cash from operations after distributions to unit holders, vastly improving its performance from the $18 million shortfall of net cash from the same quarter last year.

The recent deals in the Hugoton Basin should accelerate this improvement going forward. Even though high-yielding exploration and production companies like Linn can be riskier bets, it seems that Linn's future is more certain thanks in large part to its various portfolio upgrades in the Hugoton Basin.

Disclosure: The author is long LNCO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.