Linn Energy Is Poised for Growth

 | Aug 13, 2014 | 10:00 AM EDT  | Comments
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North American oil and gas player Linn Energy  (LINE), (LNCO) posted an "excess" of cash flow that used to be called distributable cash flow, or DCF, of $34 million. This would put Linn's DCF at 1.13x distributions. Even better, Linn updated its "excess of net cash" full-year guidance to the equivalent of 1.10x distributions, an increase from the 0.98x just two quarters ago and 1.01x guidance from last quarter.

While Linn's new acquisitions in the Hugoton are grabbing the attention of investors right now, the better-than-expected guidance is actually coming from its previous acquisition of Berry Petroleum.

The high-growth Berry acreage is now adding incremental cash flow to the bottom line. In acquiring Berry Petroleum, Linn saw the true value in Berry's acreage, and set meaningful, but beatable benchmark goals. In other words, Linn under promised, and is now over delivering.

This quarter, Linn's improved DCF results came from two other factors: Better-than-expected production results from the Hugoton Basin, where production grew by 5%, year over year, and an even more impressive 9% production growth in California. Linn's star of California was the Diatomite, where production grew an amazing 30%, year over year, this quarter.

Source: Linn Energy Investor Relations

The McKittrick portion south of the Diatomite play drove the growth in California. Before the Berry acquisition, and certainly after it, McKittrick was transitioning to steam flooding, which is an advanced method of enhanced oil recovery, or EOR. This has led to a sort of renaissance for this field, and it will drive production growth for at least the next couple years. The Diatomite has exceeded Linn's original expectation for the area, when the company acquired the assets from Berry.

While many are understandably focused on Linn's latest acquisitions in the Hugoton, I believe the properties from the Berry acquisition will drive Linn's results in the coming years. The company had to increase its share offering to make the Berry deal work. At the time, many believed that this was overpaying, and that Linn would have difficulty maintaining its distribution with the increased share count. Now, through the better-than-expected growth results in the Diatomite, we're seeing the potential that Linn's management probably saw in this acreage all along.

A major underlying strategy of many oil companies is to buy drilling rights on oil fields based on initially expected reserves, and to then, as technology advances over the years, get far more out of those fields than originally expected. For example, few people in the 1930s ever imagined that the Permian Basin would still be productive past the 1980s, but thanks to improving technology and further shale discoveries, it's 2014 and the Permian is still going strong. In fact, companies operating in the Permian Basin and many similar oil fields have been under promising and over delivering for decades.

In getting its hands on some of the best mature oilfields in the country through the Berry acquisition, I believe that Linn has put itself firmly behind that very trend. By setting goals that are manageable, and then exceeding those goals, Linn is rewarding its shareholders.

As a significant handful of upstream master limited partnerships (MLPs) revise their DCF guidance downward this quarter, thanks to myriad unaccounted for factors, Linn has set itself apart this quarter by actually exceeding its own expectations. I believe that Linn's management will continue to do so in the future.

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