As I write this units of Linn Energy LLC (NASDAQ:LINE) are heading lower while shares of affiliate LinnCo LLC (NASDAQ:LNCO) are following suit. The culprit is an article in Barron’s on the company that is highlighting comments from a recent presentation by a hedge fund that’s short the company. The article, “Twilight of a Stock-Market Darling”, is one of the many recent publications on the company that have highlighted some areas of concern. Let’s dig into the thesis of the recent concerns and see if we can glean some insight into what’s going on.
What’s being said
The article starts out by saying that Linn Energy LLC (NASDAQ:LINE) “may be the country’s most overpriced large energy producer” and goes on to say that the company had “for years used aggressive accounting to prettify its financial statements.” The crux of the article is that LINN’s fundamentals are now deteriorating and the company’s yield, which had been supporting its high unit price, might not be sustainable.
There’s no doubt about it that last quarter wasn’t a barn burner. Linn Energy LLC (NASDAQ:LINE) pointed out a number of reasons why it missed its quarterly production guidance which caused it to miss earnings this quarter. What would be most worrisome is that LINN’s distribution coverage ratio slipped to 0.88 times, meaning LINN paid out more than it should on the quarter; however, that concern will soon abate. Further, LINN is not the only upstream MLP that had trouble in the quarter, as BreitBurn Energy Partners L.P. (NASDAQ:BBEP)‘s coverage ratio slipped all the way to 0.67 times, which was well below its target ratio of 1.1-1.2 times. Linn Energy LLC (NASDAQ:LINE) and its peers face a real uphill battle in keeping that distribution stable, let alone growing it.
A wellspring of problems
The natural decline of an oil and gas well requires constant capital investments just to keep production stable. This maintenance capital issue has been a recent sore spot for the company, and bears question how LINN accounts for this spending. The worry is that LINN is aggressive in how it accounts for this spending and is therefore paying out more than it should; at some point its cash flows will dry up, and therefore so will its distribution.
Linn Energy LLC (NASDAQ:LINE) operates a unique business: It acquires mature oil and gas assets and then attempts to squeeze out every drop it can to produce income for its investors. Yet, these assets don’t produce a steady amount of oil and gas each year until they run dry. Instead, production rates decline, a fact made even more difficult due to volatile commodity prices. LINN’s reserve base has decline rates all over the map, with its Jonah Field declining by 14% per year and its California assets only declining by 3% annually. While its understandable to be concerned here, this isn’t a new issue for Linn Energy LLC (NASDAQ:LINE); it’s been battling production declines since day one.