Linn Energy : Motley Fool Review

LINN Energy LLC’s Earnings Are Full of Surprises
LINN Energy LLC and LinnCo LLC both ax their monthly distribution to conserve cash.

Linn Energy Llc Permian Tall
SOURCE: LINN ENERGY LLC

With the price of crude taking a second leg down over the past few weeks, it’s forcing oil companies to take a hard look at their future plans. Hard choices are also being made with LINN Energy LLC (NASDAQ:LINE) and affiliate LinnCo LLC (NASDAQ:LNCO) now making the difficult choice to suspend monthly cash distributions as a means to conserve cash as the downturn persists. But that was just one of the many surprises LINN Energy and LinnCo unveiled to investors in their second-quarter report.

Surprise! We’re axing the distribution
After first halving the payout earlier this year, LINN Energy and LinnCo are now suspending it indefinitely. In commenting on the move in the earnings release, CEO Mark Ellis had this to say:

After careful consideration, management has decided to recommend to the Board of Directors that it suspend payment of LINN’s distribution and LinnCo’s dividend at the end of the third quarter 2015 and reserve approximately $450 million in cash from annualized distributions. The Board and management believe this suspension to be in the best long-term interest of all company stakeholders.

As Ellis points out, the move is being made to preserve cash as LINN will save $450 million over the next year by not paying distributions. It’s money the company can use to fix its balance sheet, which has come under a lot of pressure due to persistently weak oil and gas prices. While this is a very unpleasant surprise, in all honesty it’s a prudent move given how worried investors have grown over its debt-laden balance sheet.

Surprise! We’ve buying our bonds hand over fist
The second surprise is actually directly related to that balance sheet as the company announced it was taking advantage of investor fears to buy back a huge slug of its debt at a hefty discount. Over the past month, the company has repurchased $599 million of its outstanding senior notes for a total of $392 million, or a 35% discount to par value. This is actually a really great use of capital as LINN is basically earning a 50% return on its investment in buying back these bonds at such a discount.

With those repurchases, LINN has now reduced its debt by $783 million year to date, which will save it $54 million in annual interest payments. That’s a meaningful reduction in debt for the company and this isn’t likely the last of the debt repurchases as CFO Kolja Rockov hinted in the press release of “potential future repurchases.”

Surprise! We had better cash flow and production during the quarter
Another positive surprise was the company’s operational results for the quarter, which trounced its guidance. The company had expected to produce 1,100-1,220 MMcfe/d during the quarter but actually produced 1,219 MMcfe/d, which was 1.5% higher than the second quarter of last year. Further, as a result of production right at the high end of its guidance range, the company is now able to boost its full-year production guidance by 4% given what it sees on the horizon.

In addition to this, LINN Energy produced $71 million in excess cash flow for the quarter, which was a surprising bounty given that the company was expected to have a shortfall of $20 million for the quarter. The biggest driver here, aside from the higher than expected production, was a vast improvement in expenses. Overall, the company was able to reduce its lease operating expenses by 18% year over year.

The company expects these cost reductions to continue as LINN is reducing its full-year operating expense outlook by 6%, which will drive further improvement in cash flow. Overall, the company is expecting to pull a total of $225 million out of its overall cost structure as a result of interest savings and expense reductions.

Investor takeaway
There’s no way to sugarcoat things: The distribution and dividend cuts from LINN Energy and LinnCo sting. But given the persistent weakness in oil and gas prices it’s really the right move for the company to make until there’s a bit more clarity on prices. On a more positive note, the company did make significant progress on debt reduction and its operational results were actually quite good. That being said, LINN Energy and LinnCo have a lot of work to do considering the abundance of debt and no distributions to give investors a reason to keep holding.

For investors looking to limit risk, here’s a list of U.S. shale-oil producers with market values of at least $50 million and share prices above a dollar as of Friday’s close with the highest ratios of debt to equity:

Company Ticker Debt – most recent quarter-end ($mil) Total equity ($mil) Debt/ equity Total return – November Total return – YTD
Ultra Petroleum Corp. UPL,-6.55% $3,426.000 $5.198 65,910% -13% -8%
Midstates Petroleum Co. MPO,-0.38% 1,669.150 $334.277 499% -23% -65%
Memorial Resource Development Corp. MRD,-0.32% $2,111.800 $436.278 484% -20% N/A
Isramco Inc. ISRL,-2.55% $112.712 $26.740 422% 7% 10%
Jones Energy Inc. Class A JONE,-5.25% $770.000 $182.937 421% -18% -30%
Exco Resources Inc. XCO,-9.85% $1,549.439 $427.042 363% -4% -43%
PetroQuest Energy Inc. PQ,-2.80% $422.500 $130.059 325% -21% -14%
Goodrich Petroleum Corp. GDP,-5.20% $609.464 $214.587 284% -27% -64%
Linn Energy LLC LINE,-25.93% $12,310.146 $4,932.133 250% -26% -35%
Halcon Resources Corp. HK,-2.91% $3,533.852 $1,517.866 233% -27% -41%
Total returns assume dividends are reinvested. Source: FactSet

Memorial Resource Development Corp. completed its initial offering in June, priced at $19 a share, for a total return of 14% through Friday’s close at $21.60.

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