Linn Energy LLC (LINE) is an oil and gas E & P MLP. It pays a hefty 7.35% dividend. Linn likes to buy already developed properties about which there is little doubt as to productivity. It continues production, and it develops further resources on the already significantly proven fields. Lately it has been acquiring properties at a rapid rate. Linn spent $1.35B in 2010, $1.48B in 2011, and $2.80B in 2012 to date. The chart below shows Linn Energy's acquisitions growth and its planned potential organic growth over the next few years.
Linn Energy is planning to roughly double production from about 425 MMcfe/d at the end of 2011 to about 825 MMcfe/d at the end of 2012. That's really impressive for almost any E&P developer.
Linn Energy also has a great history of raising its dividend. The Distribution history chart below shows that Linn Energy has increased its distribution by 81% since its IPO in January 2006. The distribution for the last two quarters has been $0.725 per quarter. This amounts to a 7.35% dividend annually.
On top of this Linn Energy has 100% of its oil production and 100% of its natural gas production fully hedged through at least 2016. This almost guarantees its income; and it is one of the reasons that banks are happy to help it raise money for its acquisitions.
If all this is true, how did Linn manage to miss on EPS for three out of the last four quarters? Over the last four quarters Linn Energy has cumulatively missed by $0.40 with total earnings during that period of only $1.51. That's a whopping 26.5% of total earnings during the period. On top of that the distribution coverage for Q2 was only 0.97x. If that keeps up very long, Linn Energy might have to cut its dividend instead of increasing it. That would put an investment in Linn Energy in a different light.
The main reason for the above misses has been the dramatic fall in natural gas prices and the slightly lagging fall in NGLs prices. If Linn Energy is 100% hedged in natural gas and oil, why is this a problem? The reason is that Linn Energy has no NGLs hedges. Currently NGLs hedges are suffering from backwardation. This means that the prices of NGLs futures are cheaper than the current spot prices. It makes little sense to have NGLs hedges. Some people attempt to hedge NGLs with extra oil hedges. However, this too has failed to work well recently. NGLs prices were about 60% of oil prices roughly a year ago. Now they are closer to 33% of oil prices. When the NGLs prices fall roughly twice as fast as oil prices, hedging via oil is not going to work.
The good news is that natural gas prices hit a near term bottom in the spring. They have since moved up roughly 50%. This is good for NGLs because natural gas prices provide a floor for NGLs prices. NGLs can always be left in natural gas to be sold that way. In addition the early forecasts for weather this coming winter are for an el Niño season -- a colder than normal winter. This too will push up natural gas prices, as more natural gas will be used for heating. Longer term natural gas for transportation and increased power generation from natural gas will provide increase demand in the US. Perhaps LNG export of natural gas will provide yet more. The chart below shows the EIA's near term natural gas history and forecast for prices in the US.
In addition to the above NGLs are being used more to produce ethylene, propylene, styrene, etc. These had formerly been produced from naphtha (an oil derivative). They can be produced much more cheaply in the US from ethane and other NGLs. Some existing refineries have already been converted to be able to use ethane as a raw stock material for ethylene manufacture. Other refineries are in the process of converting to NGLs use as input stocks. Exxon Mobil (NYSE:XOM), Chevron Phillips Chemical Co. -- a joint venture of ConocoPhillips (NYSE:COP) and Chevron (NYSE:CVX), Dow Chemical (NYSE:DOW), and Shell (RDS-A) have big new refineries planned to produce polyethylene, etc. This is by no means a complete list. The new and upgraded refineries will provide increased demand for NGLs in the near future.
Some might suggest that NGLs producers will soon run out of customers. However, NGLs will first replace most US ethylene, etc. manufactured from naphtha with NGLs raw stock manufactured olefins. In sync with this, companies will begin to ship more of this NGLs based manufacture of olefins, etc. to Europe, South America, and other destinations that do not have cheap NGLs to manufacture olefins from. The far cheaper raw materials costs will give the refining/manufacturing companies a huge price advantage over most of their competitors around the world. Manufacturers/refiners should have no trouble exporting huge amounts of their products. This means that US NGLs prices should rise more. This recovery is in part dependent on pipeLinn Energys and other infrastructure being built such as the ATEX Express from the Marcellus shale fields to the Gulf Coast. This is being built by Enterprise Products Partners (NYSE:EPD) and its partners: Enbridge (NYSE:ENB), Anadarko (NYSE:APC) and DCP Midstream Partners (NYSE:DPM). The pipeLinn Energy is schedule to go onLinn Energy in Q1 of 2014. It is by no means the only new NGLs pipeLinn Energy.
The above should create more demand for NGLs. NGLs prices should rise further from their lows. The huge growth described above for Linn Energy (roughly doubling production in 2012) should provide huge amounts of extra profit. This should greatly increase Linn Energy's EPS and distributable cash flow. On top of this Linn Energy is moving to emphasize oil production over natural gas and NGLs production. For example it is converting its Granite Wash drilling to the Hogshooter stratum. This is 72% oil, 14% NGLs, and 14% natural gas versus the 30% oil, 35% NGLs, and 35% natural gas distribution in the former strata being developed. This conversion to more oil development should help to significantly reduce the financial problems due to the lack of hedging for NGLs. In sum Linn Energy is managing the situation well, and it is growing fantastically. Those should be more than adequate reasons for most investors to buy Linn Energy.
The two year chart of Linn Energy gives some technical direction to this trade.
The slow stochastic sub chart shows that Linn Energy is neither oversold nor overbought. The main chart shows that Linn Energy has been in a consolidating formation since the beginning of 2011. It is hard to predict the exact future US economic conditions. However, with Linn Energy's 2012 growth and the likely further rebound in NGLs prices, Linn Energy's stock price is set up to appreciate in the next two years. Even if the world economic downturn is significant, Linn Energy's plethora of good news should at the very least help it retain its current price. Even this would be good during tough economic times. Investors would still get to collect the 7.35% dividend. This makes Linn Energy a buy. With the overall market overbought, averaging in is a good strategy.
Note: Some of the fundamental fiscal data above is from Yahoo Finance.
Good Luck Trading.