Just read on Yahoo that the analyst at GS has a $26 PT on LINE and doesn't expect a distribution cut with the assumption that oil will go back up later in 2015. He does have a neutral rating though. Would be nice to see.
Given the Saudis dependence on oil, it also says they do not want low oil prices for long as it depletes their reserves. They just may need those reserves to protect their social network when the Iranians or Russians come knocking over the fact that their production position is dramatically against their interests.
The price of the stock will go down as long as oil goes down, unless management can ease the fear with their 2015 forecast. However, it depends on ones' assumptions as to whether it matters what the oil price is near-term as it relates to the distribution (and I only care about the stability of the distribution over time).
If you assume the Q314 cash flow situation was steady state and the Q414 deficit is transitional (high to low intensity assets) and you believe the analysts that there are $400M in savings from the swaps, then, with the lower interest expense after repaying $2.3B in debt, LINE's distribution should be fine for the next 2 years. Unless management says their distribution is fine though, the stock will move with oil. And, I have clearly made 3 major assumptions to come to my conclusion, including 1) the non-recurring nature of the Q4 cash flow deficit, 2) the amount of cost reduction associated with the swaps and 3) the lack of urgency to address the debt. That's not a lot of assumptions, but if any are way off, then, everything I am banking on is off base.
Again, I am trying to work off of the data that is available. The debt does not currently worry me as much as others. That said, there are two key assumptions that have to be made to determine where LINE really stands with cash flow. First, one has to determine how much of the guided $50M+ cash shortfall in Q414 net of transaction costs is recurring and 2) how much cap-ex will be reduced with the swaps once the costly transition periods come to an end. Then, you can simply do the math on the size of the cash flow problem at differing oil prices.
IMO, the Q414 cash shortfall will continue into Q115 because the 2nd swap with Exxon will be year-end. However, since Q314 cash was $12M above the distribution level, I find it hard to believe that the Q4 cash shortfall is ongoing, as Q314 should have been more representative of the company's current state. Also, they will get the benefit of lower interest expense from repaying the $2.3B debt with completion of the transactions post-Q314.
I have to rely on the analysts (and assume they have spoken with management) and assume there are about $400M in cost reductions associated with the swaps. And, $400M would cover their cash needs down to about $50 oil in 2015 without any action on the distribution, if the Q4 cash issue is truly non-recurring.
If not, they may have another $100M to $200M to cover. On the size of their business, it's not that much to find for awhile through cost cutting (other shale producers are claiming to cut 50% and still increasing production for 2015), acquisitions or simply running sub-1X on the distribution for a time.
IMO, their real issue is if oil stays sub-$70 or $80 into 2017. I am betting it doesn't, but who knows. Yet, if oil remains at $50 or so into 2017, we are all in trouble.
You are missing the point. I don't buy into your bankruptcy theory and what you are suggesting is entirely unworkable. You can't cut the distribution 80% and expect to sell equity anywhere near current prices and you can't issue units at current prices and turn around and cut the distribution 80%. I ran a public company for 16 years before retiring and do have a bit of understanding about how these things work.
When at the current stock price you are paying a 22%+ distribution, it's not probably appropriate to put out more units to pay down debt. What does make sense, and they will likely do if they can in the coming months, is to use the unit buyback and reduce their distribution commitments moving forward. And, while I doubt they cut the distribution in 2015 or 2016, if they did cut it even 50%, it would still not be a good idea to issue units paying a 11%+ distribution to pay down debt owing 6.5% IMO. Of course, I don't agree with your suggestion that they are heading toward bankruptcy and apparently none of the analysts do either as they are all reiterating their "Buy" recommendations, albeit at PTs in the $20's and not $30's. This will pass, perhaps like a kidney stone, but it will pass in the next year or so.
I bought at $13.50, took my loss at $10, waited 30-days for tax purposes, and now started back in at $7.50. And, it may go lower, especially near-term with both tax loss sellers and shorts piling in. Still, management is doing all the right things in a very tough macro and are committed and capable of sustaining the current dividend or at least a very healthy one. Currently, their max shortfall in cash in 2015 is $1B, so with up to $10B in asset sales on the blocks, they should be able to continue to offer a very nice yield as we wait for the macro to improve. Over time, surely these high cost producers will shutter their mines and the price of iron ore will begin to work its way back up towards $80 or $85 where VALE can do quite well on lower costs and higher volumes.
I just started a position in ESV and believe it is highly unlikely we see a dividend cut in '15. If oil stays low into '16, maybe. Their balance sheet is plenty strong with the $1.3B debt offering and increase in the revolver to $2.25B to protect the dividend for quite some time, unless they just elect not to.
Unless they just want to cut the dividend to use the money for other purposes, they have no need to cut it in 2015. They just raised $1.3B and increased their line of credit to $2.25B. As such, I doubt they make a cut in 2015 because management has made it clear that they want to be a high yielder.
I agree that Russia is a component, though I do not agree with your take on the availability of oil in the U.S. But, I think think Russia is secondary to Iran. The Saudis hate Iran and don't want Iran to get nuclear weapons any more than the U.S. does. IMO, Iran's nuclear program is the main target of the Saudis and it just so happens it works out well for the U.S. vis-a-vis Russia as well. Come the next OPEC meeting, I suspect the proposition will be that if Iran shutters it's nuclear program the Saudis will cut production. By then, production investments will be dramatically reduced in high cost areas and global demand for oil may be increasing due to the lower prices as well as the projected global economic improvement starting mid-2015 (if it actually happens).
As for the distribution, if the $400M number being bantered about by the analysts as the cost reduction available to LINE with the asset swaps is in the ballpark, I don't believe LINE will need to cut the distribution in 2015 or 2016. However, they will perhaps need to supplement the $400M cost reduction from the swaps with a few additional cuts and perhaps even an accretive acquisition or two as well as a unit buyback. At these prices, they could implement their $250M buyback and reduce the distribution commitment about $60M. My understanding is their debt covenants permit them a $500M buyback which would cut distributions $120M. Lot's of possible ways to protect the distribution near-term.
LINE will only move higher when one of the following occur.
1. Oil prices reverse course and move towards levels that eliminate the uncertainty of the distribution.
2. Management lays out their 2015 Plan and gives investors confidence that the distribution is sustainable.
I wish it were as simple as a change in the calendar or the washing out of tax loss sales, but I suspect it's not that easy.
I agree entirely. We need this entire cycle to play out before the hedges expire on oil in 2017, so the quicker we get to a bottom, the sooner those that can do something to balance supply with demand will be forced to take action. Whether that action is OPEC, or OPEC and Russia, cutting supply, or a conflict created by an unwillingness of the parties to cooperate, the sooner the better for getting oil moving back in the right direction.
I went to the local Verizon store yesterday and purchased two 6's with 64GB for Christmas presents. They were in stock, though the salesman had to check supply to be certain. Seems perhaps the supply is catching up for the holidays and should bode well for the quarter.
Just read an article about two shale producers who are cutting cap-ex 50% in 2015, one from $1.45B to between $750 and $850 million, yet still growing production a few percent. I thought this was interesting because it might give some comfort in the magnitude of cap-ex reductions LINE could pursue, if needed, for a period of time to weather the storm.
It would seem to me that at $60 oil, LINE needs to find $250M to $450M (depending on how much of the projected Q414 cash shortfall is recurring). At $50 oil, they need to find about $350M to $550M. I would like to think most of the cash shortfall in Q4 is non-recurring transition costs from high-intensity to low-intensity assets because I can't otherwise explain how they were $12M positive on cash in Q3 on a steady state basis and negative in Q4.
As these figures relate to the distribution, it suggests a few things, 1) if others can cut cap-ex 50% and still increase production, then, LINE may be able to cover their entire need with cost reductions, or cost reductions and running sub-1X on the distribution for awhile, 2) if not, any cut in the distribution could be modest as even a reduction to $2.00 would produce $300M and 3) they still have other levers to pull before cutting the distribution, including non-capital expense reductions, accretive acquisitions and stock buybacks.
Nice post. I have family in central Mississippi and my father in-law was commenting over Thanksgiving that quite a few locals go down to the coast to work on oil rigs and how a couple were already laid off. So, perhaps it has already started.
That's interesting. Just this past Friday he said that ESV has a strong balance sheet and should be able to cover the dividend at the current rate with little issue since they just raised $1.3B and increased their line of credit to $2.25B. I didn't see what you are referring to him saying, but it would be an about face from just last week.
Therein lies the uncertainty. If oil prices are still at $60 or lower entering 2017, LINE has a major problem as they exist today. In the meantime, the hedges help, but they can still probably only withstand $60 oil for a couple of quarters before reducing the distribution somewhat. Bottom line, I think the bet is "will oil settle in for awhile at $60+ to permit LINE to sustain the distribution in 2015 and 2016, and will it rise above $80 or $85 by 2017 to allow them to support the distribution without hedges. Don't forget, it's not like the nat gas hedges are looking better either over this period as the hedged pricing reduces over time.
The investment binge ends in 2015 and their cash flow with asset sales included will carry them past their investment binge with regards to the dividend. Even analysts agree that their dividend is readily covered by the expected cash flows, including asset sales. So, what data are you using to suggest VALE's dividend is unsafe?
Let's face it, unlike LINE, you can sell LNCO without the ordinary income issue associated with the LINE distributions. I sold my LNCO for this very reason and held my LINE. In time, both will rise, but LNCO will perhaps do some catching up after tax time ends. I am looking to get back into LNCO, but haven't yet.