Linn Energy: Aggressive Hedges And Production Growth Support Distribution Coverage

| About: Linn Energy, (LINEQ)

Linn Energy LLC (LINE) grew its first-quarter average daily production by a whopping 51 percent in the first quarter of 2012. Liquid hydrocarbons accounted for much of this growth.

During the quarter, the limited liability company (LLC) drilled three successful wells in the Granite Wash, an area that accounts for 40 percent of the firm's 2012 capital expenditures.

Linn Energy has also announced $1.8 billion in acquisitions in recent months, including a joint venture with Anadarko Petroleum Corp (NYSE:APC) to use carbon dioxide to enhance production from a mature oil field in Wyoming.

Thanks to management's policy of hedging the majority of production years in advance, Linn Energy's average price realizations for natural gas came in at $6.33 per thousand cubic feet in the first quarter-well above prevailing prices.

Linn Energy has hedged 100 percent of its expected natural gas production through the end of 2017, protecting the firm's cash flow from fluctuations in commodity prices for almost six years. The LLC has also hedged 100 percent of its oil production through 2015 and 70 percent of its NGL output over the next five years.

Although the firm's production mix favors oil, management has shifted its acquisition strategy of late to acquire low-risk natural gas reserves at deep discounts that guarantee solid returns.

The proof of Linn Energy's success is in its first-quarter bottom line. The company reported a headline earnings loss from hedges, which is irrelevant for MLPs. The best measure of profitability-distributable cash flow-increased by 43.8 percent from year-ago levels and covered Linn Energy's recently boosted quarterly payout by a 1.14-to-1 margin.

Management expects the LLC to grow its production by 65 percent in 2012 and to generate enough cash flow to cover its distribution more than 1.2 times in the back half of the year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.