Bookkeeping: Cutting Linn Energy (LINE) on Barron's Mention

Linn Energy (LINE) was mentioned prominently in this week's Barron's and is up nearly 20%. I am going to take this opportunity to cut most of the position and we'll try to buy this back on a pullback since such a huge gap in the chart was created. In a bull market I'd probably just let this name run, but in a bear market all gains are to be grabbed and savored. Further, before today's move the stock was stuck under its 200 day moving average, so it's not a promising chart unless today's move is held. I kept it as a major position but only because I felt there was a major disconnect between perception and reality in this stock. So we sort of got a gift today.

• THE COLLAPSE IN NATURAL-GAS and oil markets has sent the price of Linn Energy plummeting in the past six months, from over $25 in June to below $12 last week. Linn, a modest-sized gas and oil driller, is structured as a master limited partnership, paying out some 60% to 70% of its quarterly cash flow to its shareholders in tax-advantaged distributions. The big fear among investors is that those payouts will soon wither as a result of weak energy prices.
• And as if that weren't enough, Wall Street worries that frozen capital markets will keep Linn from following its growth-through-acquisition policy that in the past has permitted the partnership to boost quarterly cash flows and therefore unit distributions.
• Such concerns seem amiss. For one thing, Linn (ticker: LINE) is an astute and disciplined hedger and, as such, was able to lock in favorable prices during this summer's energy-price bubble for its products going out three to four years. In fact, based on its third-quarter distribution of 63 cents per unit (or $2.52 annualized), the company is throwing off a current yield of more than 20%.
• Citigroup analyst Richard Roy wrote in a recent report that this distribution level is "relatively secure" for at least the next two years or more, even if Linn makes no new acquisitions in the period. As a result, Roy has a one-year price target on Linn of 22, while John Kang of RBC Capital Markets sets an even higher target price of 27, more than double the current level.
• LINN'S OPERATING PHILOSOPHY is a conservative one, emphasizing yield generation over flashy new discoveries. As such, the company concentrates its acquisition and drilling activity on mature fields that have ample reserves but no longer produce at the high levels favored by the majors or aggressive exploration outfits. "We're looking for bunt singles and not home runs," avers Michael Linn, chairman and CEO of the eponymous company, who grew up in Pittsburgh but now runs the company out of Houston.
  
• The company's fields typically have 20-to-30-year lives and undergo slow annual production declines. They also afford ample opportunity to boost production through reworking old bore holes, pumping equipment, water-injection systems and lifts. The geology of the fields is such that Linn generally has a near 100% success rate when it drills.
  
• Even in a steady state with no new acquisitions, CEO Linn claims that the company can keep its production levels, and therefore distributions, flat or gently rising through work-overs and drilling additional wells on its existing acreage. The company has identified 4,100 low-risk drilling locations on its properties with promise of boosting production. "That's about 15 years worth of drilling at our current pace, or 200 to 300 wells a year," he says. "We could keep our production going at current levels with just 150 new wells a year."
• And the company is not without financial flexibility, even in today's severe credit crunch. It opportunistically sold off three different properties so far this year for a total of around $1 billion, taking advantage of the frenzy in oil and gas speculation this summer. A particularly hot item was Linn's Marcellus Shale acreage in Pennsylvania's Appalachian Basin, which Linn adjudged to be promising but too expensive for a company of its ilk to develop.
• AS A RESULT OF THE SALES, LINN now has about $500 million of borrowing capacity under its credit facility. This is after taking into account a $100 million stock- repurchase plan that the company has instituted but not unleashed. The latter gives the company plenty of potential firepower with which to defend its stock price. The company says it will be able to cover all of its capital spending and unit distributions next year from internally generated cash flow.
• Crucial to Linn's rich distributions and past growth has been its hedging programs. First off, the company generally hedges, or locks in profit margins, on a higher percentage of its future production than its competitors. It also hedges production for more years in the future than certain of its rivals. Linn's current production levels are hedged 99% for next year, 107% for 2010, 101% for 2011 and 66% for 2012 -- far greater coverage than at most rivals. (this is why we bought it but nobody seems to care until Barron's points it out)
• As primarily a yield play for older investors, the company tries to be as plain and drab as "an old Chevrolet door handle," in the words of Michael Linn.

I still like Linn for the massive yield.... and oil probably should fall to $25 as its worst case?

Selling Linn Energy in the $14.10s, taking it from a 2.1% stake to 0.1%

6 months ago if Israel was making a fuss over Gaza, oil would be up $10... today it's up a buck or so. Not that there is any oil in these countries but speculators use any excuse in a bull market to run a commodity up. It appears the hedge funds have completely abandoned oil speculation... err, I mean it appears the laws of supply and demand in the "efficient market" seem to have changed materially in the past few months.

[Oct 21: Bookkeeping - Starting Linn Energy]

Long Linn Energy in fund; no personal position