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We have a positive stance on Linn Energy LLC (LINE) given its high dividend yield and the fact that it has a 100% hedged production of oil and natural gas until 2017 and 2016, respectively. The company has seen significant growth since its formation in 2003 and is expected to continue to do so.

However, we highlight the cash flow situation of the company and decreased natural gas liquid prices as causes for concern for the company.

Company Overview

Linn Energy is an independent energy company involved in the exploration, drilling and production of oil, natural gas, and natural gas liquids (NGL). The company currently has operations and ownership interests in the U.S., including properties in the Mid-Continent, Michigan, the Permian Basin, the Williston Basin, and California.

The company started operations in 2003 and is based in Houston, Texas. It has seen immense growth and emerged as one of the top 10 independent exploration and production ((E&P)) companies in the U.S, with a market cap of $7.78 billion.

Earnings Review

Linn Energy announced revenues of approximately $347 million in the second quarter of 2012, showing an increase of 15% as compared to the same period last year. The increase in revenue is due to the increased production of hydrocarbons, which more than offset the decreasing prices of hydrocarbons in the U.S. The reported revenue missed the mean revenue estimates of $470.68 million by 26.2% due to the depressed prices of hydrocarbons in the U.S.

Linn Energy announced EPS of $0.31 for the second quarter of 2012, showing a decrease of 34% compared to the same period last year, missing the mean EPS consensus of $0.42 by 27%. The decrease in EPS was due to the depressed prices of natural gas liquids, which are now being considered a multiyear phenomenon by the management. The company's lease operating expenditure was $1.22 per Mcfe, showing a decrease of 29% as compared to the same period last year.

$ Million

% Change

Q2 2012

Q2 2011

Q2 2012E

Deviation

Revenue

15%

347.23

302.39

470.68

-26.20%

EPS

-34%

0.31

0.47

0.423

-26.70%

Cash Flow from Operations and Capital Expenditure and Borrowings

The cash flow from operations was -$122.4 million, due to cash payments of $583 million. The increase in capital expenditures was due to acquisitions of oil and natural gas properties for $1.76 billion.

The company borrowed debt of about $3.95 billion in the second quarter of 2012, as compared to $1.39 billion in the previous year.

$ Millions

Q2 2012

Q2 2011

% Change

Cash Flow from Operations

(122.4)

35.5

-445%

Capital Expenditures

(1785.4)

(1240.2)

44%

Hedging

The company has hedged its natural gas and oil production till 2016, and the derivatives (fixed rate swaps and put options) will contribute to the bottom line of the company going forward, provided the prices of oil and natural gas remain below the strike price; details for the hedging positions undertaken by the company have been presented in the table below. However, NGL, which account for about 23% of the hydrocarbon production, have not been hedged by the company.

Weighted Average hedge price

Expected production hedged until

Production

Oil

$97.26/bbl

2017

100%

Natural Gas

$5.28/Mcf

2016

100%

Acquisitions

Linn Energy announced that it would go ahead with acquisitions and joint venture agreements of about $2.8 billion in 2012. As mentioned above, the company's cash flow from operations was in the negative, so the company will have to increase its borrowings or issue equity to complete its acquisition.

Production and Reserves

The average daily production of Linn Energy increased 76% to 630 MMcfe/d for the second quarter of 2012, as compared to 358 MMcfe/d for the second quarter of 2011. The above mentioned acquisitions are expected to add 300 MMcfe/d of production and increase the total reserves by 1.7 Tcfe to 5.1 Tcfe.

Outlook

The company has hedged 100% of its expected production for natural gas and oil till 2016 and 2017, which are above the prevalent prices of the commodities. The company has achieved significant growth over the years and has seen its reserves and production increase significantly.

However, a cause for concern, as highlighted above, is the cash flow situation of the company, which worsened due to extensive and prolonged hedging positions undertaken by the company and the continued decreased prices of natural gas liquids, which will continue to exert negative pressure on the Linn Energy's profitability.

As most of the expected productions of oil and natural gas for Linn Energy are hedged at prices mentioned above, an increase in the prices taking them above these levels will be detrimental for the profitability of the company. Therefore, it is safe to consider Linn Energy as a play against a rebound in oil and natural gas prices, and a beneficiary of depressed oil and natural gas through its hedging positions locked in by derivatives.

Trading at forward EV/EBITDA, P/B and P/S multiples of 7.43 times, 2.27 times, and 4.8 times, and offering one of the highest dividend yields of 7.43%, we have a positive stance on Linn Energy.

Name

PE

EV/EBITDA

Dividend Yield (%)

ROE (%)

P/B

P/S

Linn Energy LLC

22x

7.7x

7.43

14.10

2.27x

4.80x

Devon Energy Corp (DVN)

17x

4.1x

1.36

10.49

1.11x

2.07x

Chesapeake Energy Corp (CHK)

22x

5.2x

1.82

10.93

0.77x

1.1x

Source: Buy Linn Energy: 7% Dividend Yield, Hedged Production Of Oil And Natural Gas