LINN Energy hedging concerns overblown, says Wells Fargo Wells Fargo believes commentary made by an anonymous short seller as mentioned in LINN Energy's late Friday regulatory filing and the Barron's article this weekend on the company overstate the impact of LINN Energy's hedging strategy. Wells says recent concerns over LINN are overblown and maintains an Outperform rating on the stock.
UBS writes (acquired from the IV board):
Over the last few weeks, questions of LINE’s treatment (and accounting) of its put contracts have been raised. Some investors believe the cost of put contracts should be expensed not capitalized, as has been LINE’s practice. Such questions prompted Barron’s to feature LINE in its latest issue, recommending investors ‘steer clear’ in favor of larger C-corp producers. We disagree with this conclusion, affirm our Buy rating, and seek to clarify LINE’s use - and treatment of – its hedge positions.
Commodity hedging: a core tenant of LINE’s stated strategy
The active hedging of oil & natural gas production has been a stated, core strategy of LINE since its 2006 IPO. Mgmt has consistently used a combination of swap & put contracts to diminish its sensitivity to volatile commodity prices and to ensure targeted accretion from acquisitions. This dedication to hedging has mitigated the impact of commodity price swings, enabled LINE to remain acquisitive during market downturns, and to grow its quarterly distribution 80% since its IPO.
Puts typically comprise ~30% of total LINE hedge positions
LINE’s business practice has always been to budget ~10% of an acquisition’s cost for puts. As such, LINE pays for the put upfront and capitalizes it as an asset on its Balance Sheet. As a result, the company’s hedge portfolio typically includes 70% swaps and 30% puts. The use of puts is voluntary and better insulates LINE’s cash flow (vs. peers) as put contracts allow LINE to retain upside to future price moves.
Valuation: Maintain Buy rating
We affirm our $42 DDM-derived price target and Buy rating on LINE units.
In a note to investors this morning, Wells Fargo analyst Praneeth Satish said that the short-seller and Barron's reports overstate the impact of LINN's treatment of its derivative contracts on the company's financials. Satish added that the issue is not new, having been brought up previously as far back as 2010, and reiterated the firm's Outperform rating on the stock.