LINN Energy Still Has Bargain Potential

 | Dec 11, 2013 | 12:00 PM EST  | Comments
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bbep

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memp

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mcep

It has been a rough ride in 2013 for investors who have been long Linn Energy (LINE). Back in February, management announced its transformative acquisition of Berry Petroleum. While analysts were excited about the prospect, attacks from both vocal hedge funds and a major magazine ensued.

Then, in July, Linn announced that the Securities and Exchange Commission had opened an informal inquiry into the company's hedging strategy, pending acquisition and a few other things. Units of the partnership tumbled, diving to as low as $22 in August.

Thankfully, things have since gotten better. In late October, the SEC announced it had no further comment regarding Linn's acquisition of Berry. Investors took that as a sign that the worst was over and began frantically getting back in. Units of LINE now sit at just under $31. But is Linn still a good bargain?

A cursory glance would seem to indicate that it isn't. Based on 2013 guidance, LINE units trade at almost 11x discounted cash flow. That is a good bit higher than BreitBurn Energy (BBEP) at just below 10x. Memorial Production Partners (MEMP) trades even lower at 9.2x, and Mid-Con (MCEP) sits at a very low 8.6x this year's DCF guidance. In addition, Linn's DCF coverage ratio for the year is a razor thin 1.01x distributions. Most other names in this space provide coverage of at least 1.05x. Some of the better performers this year, such as BreitBurn, Memorial and Mid-Con, all have annual coverage ratios of over 1.1x DCF right now.

While it may not be the distressed bargain that it was a few months ago, we should consider a few important things about Linn. The company has huge acreage positions in two places that the other partnerships have difficulty acquiring in: the Permian Basin and the San Joaquin Valley. Both places provide high margin oil. Both have solid growth potential through enhanced recovery methods, which could extend the lives of these fields substantially. After the Berry acquisition is approved, which looks increasingly certain, Linn's position in both the Permian and San Joaquin Valley will be unrivaled by other MLPs.

Management expects to organically grow production by high single-digits for at least the next few years. Nearly all of this growth will come from oil. Other MLPs cannot match this kind of oil-heavy growth. Not organically at least. Where is all this growth coming from? While Texas and California make up the bulk of Linn's oil production growth, there is also some very substantial, double-digit growth coming from the Uinta Basin in Utah.

So yes, there may be better values than Linn Energy right now. And these better values are not necessarily sub-par names, either. Many of these cheaper names have safer distributions and comparable margins. However, when we look at the long-term growth prospects coming out of some key spots, and consider the life-expanding enhanced recovery potential on top of that, Linn is a very unique name among upstream MLPs.

If your horizon is over five years, Linn may still be the best name, despite the higher valuation. At about 11x earnings and at a yield of over 9.5%, Linn is still a fine place to start.         

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