Quick Take: LINN Energy is in prime position today as an upstream MLP to take advantage of low interest rates and an opportunistic acquisition environment. We think the next 12 months could bring significant additional accretive deal flow to the Company, and we estimate LINE can grow its distribution ahead of its 5% targeted schedule. As a result of our high growth estimate, we are initiating LINE with a Sector Outperform rating and a $44 price target, based on a 7% long-term average yield assumption and 5% distribution growth in 2013. We expect total return to LINE unit
holders in 2013 of 16-25%.
The Perfect Storm: The next 12 months could be transformational for LINE with the market environment ripe for the Company to grow distributable cash flow. Current interest rates provide a low cost of capital to fund the acquisitive growth, as well as increase the demand for the yield vehicle. Further, the backlog of assets for sale is at peak levels as lower-valued traditional E&Ps have adopted a strategy to help fund capital spending via asset sales, and many now find
themselves over-levered. LINE should have its hands full scanning deals and could even attempt a corporate transaction this year.
Low-risk Asset Base: LINE’s existing assets consist of a high PDP percentage of reserves and are primarily long life. The Company has low geologic risk due to the mature nature of the assets. Further, LINE hedges production out 5 or more years, protecting cash flows from volatility and allowing for commodity agnostic transactions.
LinnCo, LLC: LNCO successfully IPO’d in October 2012, receiving high interest and opening the institutional investor market for LINE. LNCO is a unique product as its only asset is LINE shares (besides cash). It cannot hold debt and allows LINN Energy to raise capital from institutions as one of few efficient ways to play the MLP yielddriven market. This greater access to capital could allow LINE to undertake larger asset acquisitions or corporate deals to grow distributable cash flow even quicker. As a result of this ideal market environment, its unique institutional product nature, and ability to accelerate growth, we are initiating LNCO with a Sector Outperform rating and $42 price target. We estimate total return to LNCO shareholders in 2013 of 10-19%.
The Company has had difficulty hedging NGLs, which represent ~25% of current production. NGL pricing should improve for LINE in 2013 as ~70% of NGL volumes went to Conway in 2Q12, but after contracts roll off this year and new pipes come into service, we estimate ~70% will go to receive better pricing at Mt. Belvieu by the end of the year.
After the high 2012 acquisition pace, LINE’s balance sheet has expanded and is now outside of the
Company’s target range. While the LNCO IPO helped reduce the leverage level, we think the Company is targeting investment grade metrics and likely will be reluctant to fund near-term acquisitions with as high a percentage of debt vs. equity. We currently model LINE’s debt-to-equity and debt-to-forward EBITDA at 56% and ~4x, respectively.
LINE’s comfort level is likely closer to 3-3.5x EBITDA, which is higher than typical C-corps, but
due to the significant hedge book, the Company can support higher leverage levels. Near-term acquisitions will likely be more influenced by the balance sheet than previously, with a preference for equity capital over significant additional debt. Further, LINE can call up to 35% of its outstanding bonds if the Company issues equity, which could add accretion from lower interest expense. As the Company grows further, we estimate an upgrade to investment grade credit could save ~$40MM or more in annual interest expense, or add ~$0.17/unit to Distributable Cash Flow. LINE has
ample liquidity with ~$2 billion available on the revolving credit line and long-dated note maturities .
Looking forward, LINE is likely to continue to target low decline, long reserve life assets. We estimate the overall corporate decline for the Company to be ~20%, and the Company is targeting even lower declines with recent acquisitions like the BP Hugoton deal with a 7% decline. The longer reserve life translates into a more secure current distribution and increased ability to grow the distribution in the future.
How interesting that many of the comments I made regarding the balance sheet were echoed by Howard Weill boutique...targeting 3.0-3.5x debt/ebitda ratio...I guess that metric does matter :-)
Also interesting that they note the overall company decline rate is now 20%..this is no doubt heavily influenced by the Granite Wash drilling, where decline rates are high. Not a deal breaker, they just have to have the discipline to set their maintenance capex level appropriately and not base the distributions off of peak (flush) production rates..which no doubt they are prudent enough to understand.
I noticed that too, rrb (which is why I included that part of the report. The report itself is sixteen pages long, including a bunch of graphs and spreadsheets.)
The 20% decline rate is actually quite low compared to E&Ps that operate primarily in one basin such as Eagle Ford or Bakken.
Some interesting data per your prior observations:
Accretion per $100M Purchase Price by acquisition, and accretion per unit:
Jonah Field: .05, .26
Salt Creek: -.01 (but improving to 0.09 by 2016); -.01, 0.18 by 2016
Hugoton: .03, .09
East Texas: .05, .04
Granite Wash: .06; .16
Okay. The post is now on IV's MLP board with credit to Roger for the catch so he can be the one who goes to jail for unauthorized something or other. Then again, I believe there's no extradition treaty with Brazil. Great chance to learn Portugeuse.
Thanks, Roger. That is as glowingly positive a report as I've read. I do feel more sanguine about the company's prospects and finances than before. I'll try to copy your post and paste it on IV's MLP board. The more circulation this analysis receives, the more attention will redound to LINE.
Also, I find it provocative that Weil's target for LINE is 44 while the forecast for LNCO is 42. I've been regularly shaking my baffled noggin about LNCO selling at a premium to LINE when I feel it should be the other way around.