The Line on Linn

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For all the wealth generated by US domestic energy production, one sad reality remains: energy producers don’t always produce profits for investors.  Just ask anyone who invested in Sandridge Energy over the past two years.  Particularly for natural gas producers, commodity prices have pressured profit margins and earnings.  Oil producers in the Bakken oil shale play face the prospect of rapid depletion, and with it higher drilling and replenishment costs.  One company, though, may have found a way to make money in energy production despite the obstacles.  

A Different Approach
Up front and unapologetically, Linn Energy (NASDAQ: LINE) acquires long life oil and natural gas producing assets.  From Michigan to California, North Dakota to Texas, Linn operates 15,000 gas and oil wells with another 7,000 potentials sites in reserve.  Additional long term assets in California, Texas, and Kansas give Linn a solid foundation of wells that generate cash for additional acquisitions.  Those acquisitions tend to be oil or gas sites with predictable production, albeit with lower growth.  In 2012, Linn made over $2.5 billion worth of acquisitions, and more are planned for 2013.  Even better, while growing its portfolio of productive assets, Linn generates savings through its gas collection pipelines and water gathering system in its Granite Wash and other fields in the Texas panhandle.  

On top of it all, Linn has hedged its gas production to 2017 and its oil production to 2016 to protect it against falling commodity prices while permitting upside benefits should prices rise.  In the May 2012 edition of Oil and Gas Investor, this hedging activity was referred to as a “secret sauce” that helps Linn maintain revenue and distributions in good times or bad.  CEO Mark Ellis has described hedging as “the core of our business model.”

Speaking of the Granite Wash
Within the Granite Wash formation is the Hogshooter Wash.  A younger and shallower formation than others in the Granite Wash, Hogshooter was first exploited by Apache Corporation (NYSE: APA) in 2010.  Initial production was over 2000 b/d, which dropped off to 700 b/d.  Linn began drilling the Hogshooter in Q1 2012, and its first three wells delivered even better results than Apache’s wells.  A company spokesman confirmed Linn remains active in the Hogshooter, drilling a total of 25 wells in 2012.  The Mayfield play in Oklahoma, also part of the Granite Wash, has been tentatively explored and Linn is hopeful about the production it will bring.  For 2013, the Granite Wash will be a key focus of Linn’s exploration activities.

Has Apache left the Granite Wash to Linn?  Not by a long shot.  The Texas panhandle region contains an estimated 5% of Apache's worldwide proven reserves in one million acres of production assets.  Asset acquisition remains active, with mergers and purchases doubling acreage in the area during 2012.  Drilling activity looks to increase as well.  While Apache has world-wide assets, some of these are in Egypt, Argentina and Kenya,  places that may not take kindly to American capitalism, or may have political unrest.  Thus, this American onshore play becomes important to Apache's growth.  As an investment, Apache sells for less than 14 times earnings and is well off its 52 week high, so this may represent a good long term value play.  With a dividend of less than 1%, it's certainly not an income investment.

What else to like?
In reading various pages on the corporate website, Linn mentions partnerships to help bring newly acquired assets into its revenue stream.  One example is a partnership with Anadarko to produce oil from mature fields in Wyoming using so-called CO2 enhanced oil recovery.  Anadarko knows how to do it and Linn is not too proud to join Anadarko in using this technology to improve production.  That Linn will learn something about CO2 enhanced recovery doesn’t hurt, either.  Other, unnamed, partners are helping Linn rapidly bring its Rocky Mountain assets online.

So how has Linn performed for investors?
A review of the company’s returns clearly shows Linn produces distributions.  Stock appreciation is another matter.

               

While dividends have steadily climbed and currently yield about 7.5%, the stock hasn’t performed well over the past two years.  Obviously, it would be nice to see another 2009-2011 run, but future earnings reports, like the one scheduled for Feb. 21, will have to be favorably surprising. 

What gives with LinnCo?
Linn launched an IPO of LinnCo (NASDAQ: LNCO) in October 2012.  Its sole purpose is to own Linn units, collect the distributions, and pay them out as common dividends.  This allows certain types of institutional investors to invest in Linn and takes away some of the income tax related headaches that comes with a MLP.  In terms of return, the current dividend is 7.1%, lower than Linn Energy's current 7.4%.  LinnCo was launched last October, so it's too early to comment on stock performance.  Right now the question for investors is do I want a slightly lower yield with an easy to use Form 1099, or more yield with the hassle of a Schedule K-1?

Whither the Foolish Future?
When launched as an IPO in 2006, Linn was a $600 million enterprise value company.  Today, it’s a $14.7 billion company with ambitions to grow to $20 billion by the end of 2013.  This growth will occur through ongoing organic production and acquisitions.  Its size gives Linn access to sufficient credit on good terms to allow billion dollar deals.  This combination of steadily producing assets, hedging, and acquisitions represent a “perfect storm” for investors looking to cash in on America’s domestic energy industry.


dylan588 has a position in Linn. The Motley Fool owns shares of Apache. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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