The One Energy Company I’m Buying Right Now
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The first trade I’m recommending for my “No Drip, No Mess” Portfolio is in one of the leading independent oil & gas companies in the country, but one with which you many not be familiar. Houston-based Linn Energy (NASDAQ: LINE) has a mission to acquire, develop and maximize the cash flow from a portfolio of long-life oil and gas assets.
I think that the large dividends produced thanks to its LLC structure will continue to grow to supply us with a continual flow of cash to reinvest in exciting growth stocks that are beginning to show up on our watch list. Linn is a company I know well and instead of just buying Linn outright, I want to write puts on Linn in order to earn some income while hopefully buying shares a little bit cheaper.
Linn has a very diverse asset base of 48% oil and NGLs and 52% natural gas over a half dozen resource basins. They have about 4.3 Tcfe in total proved reserves and a 19-year reserve-life and over 1,500 low risk and liquids-rich drilling locations. Linn isn’t a play on rising commodity prices, but is simply a stable income producer as they’ve hedged out 100% of their natural gas production through 2017 and 100% of their oil through 2016. What we are buying with Linn is a portfolio of producing assets with upside through both acquisitions and organic growth.
Linn’s made three terrific acquisitions and joint ventures over the past year, such as purchasing 23% of Anadarko’s (NYSE: APC) Salt Creek enhanced oil recovery project in Wyoming, their recent foray into east Texas by purchasing the Overton Field from watchlist company Southwestern Energy (NYSE: SWN), and the largest purchase of the year, the $1.2 Billion Hugoton Field in Kansas from BP (NYSE: BP). In the case of the Anadarko venture they are getting access to technology that could be redeployed in other Linn oil assets in the future in a framework that is very low risk to Linn, whereas the Southwestern and BP deals were for older assets that fit much better in Linn’s MLP like business model. It gave both sellers cash that they could use to help fund higher return exploration drilling. Linn also acquired the Jayhawk Gas Processing Plant as part of the BP deal, which is currently only 41% utilized, giving them a lot of upside in that asset.
Why Write Puts?
I think the current price for Linn of just over $36 a share is a fair price to pay for the shares especially given their current yield at just over 8%. However, with all the concern over in Europe as well as in our own economy currently driving down commodity prices Linn’s shares have been sliding with those of the rest of the industry. Shares could have further to slide, and this volatility has the October $35 puts paying just over $2 per share for a near 6% yield on the cash used to hold the trade open. We can write these puts and immediately use the cash to invest in something from our watchlist. If we are able to pick up shares on the first put write we’ll be locking in $290 worth of annual cash flow for each put written while also having picked up the $200 in put premiums. So, as you can see using options can really help to increase the yield on the portfolio and help reduce the risks of buying growth stocks.
Risks and why sell?
One concern is that Linn will sell off assets too quickly like they did a few years ago when they sold the Appalachian assets to ExxonMobil’s (NYSE: XOM) now subsidiary XTO Energy for $600 million. At the time those assets were more growth oriented thanks to the boom in the Marcellus, but with the company’s renewed focus on organic growth it would seem that they sold too early. Exxon's XTO subsidiary was able to acquire some great acreage that would have meant more to Linn over the longer term given the size differential of the two companies. On the other end of the spectrum, Linn could become overly aggressive in acquiring new assets by both overpaying and over levering.
For the “No Drip, No Mess” Portfolio I’ll be writing one put on Linn for a 3.5% allocation, which I think is a good place to start. We’ll most likely try and own three energy stocks for up to 10% of the total portfolio. I view Linn as a long-term core holding for the portfolio and if we don’t get shares on the first try we’ll look to continue to write puts until we do finally get shares. From there we’ll more than likely just hold shares and collect the dividend but if the current yield ever dropped to 5% due to price appreciation we might look to write covered calls to earn additional income and possibly exit our position. I'll place this trade virtually via a market order at tomorrow's open.
latimerburned owns shares of Linn Energy, LLC. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.