For a few weeks now I’ve been looking into LINN Energy (NASDAQ: LINE), trying to figure out if this double digit yielding company who’s stock took a serious beat a few months ago and hasn’t recovered since. While I’m no expert, it became very evident based on the few reports I got my hands on that this is a name worth getting into.
As general practice, I’d like to lay out the negatives first, because there are always negatives… The stock took a serious hit back in July 2013 after an SEC inquiry regarding LINE’s accounting practices. As a response, LINE Energy filed a S-4/A disclosing some major accounting irregularities around September 2013. Curiously enough, the fact that the SEC was looking into the company caused a serious dip, but the actual disclosure of some irregularities didn’t have as big of an effect. The SEC hasn’t disclosed anything about their investigation as of now. On top of this, LINN Energy announced in February the attempted acquisition of Berry Petroleum (NYSE: BRY) but hasn’t started the merger mainly because the SEC is taking its time with the paperwork of the deal, which is all tied into this investigation.
Believe it or not any accounting issue in a company, even an issue that’s legally acceptable, is one of the biggest nightmares for most investors. Accounting work is the basis of most technical analysis and small irregularities usually cause huge differences in projections. However, those that were scared by these irregularities aren’t looking beyond the initial scare… LINE has more than 3 trillion cubic feet equivalent of proved developed reserves and another 2 billion cubic feet equivalent of proved undeveloped reserves besides an insane hedge book, a gas plant and some other facilities which land them at around $10 billion worth of assets. On top of that, LINE has another 14 trillion cubic feet of unproved drilling inventory, which is estimated to be worth between $6.5 billion to $11 billion (and isn’t counted in the $10 billion mentioned above).
Now lets talk positives…
First of all, the Berry Petroleum merger. This is a company with over 3,000 producing wells that cover more than 202,000 acres of land. With BRY’s properties, LINE’s production could potentially increase anywhere around 20%-40%. On top of that, a good portion of BRY’s reserves are in oil (something like three quarters). To sweeten the deal, most of BRY’s assets are relatively low-decline in quality kind of assets (long-life assets), which LINE can benefit from quite a bit. Once the SEC are through with their investigations and clear this merger, I wouldn’t be surprised with a conservative 10%-15% increase in stock value on the same day of the announcement.
Besides the BRY merger, LINE also announced the acquisition of properties within the Permian Basin region. Once the acquisition is through, LINE intend to drill about 300 wells over the next 4-5 years. Their predictions are of net production of about 4,800 Boe/d. This acquisition is another addition into the massive amounts of assets LINE controls and can potentially be a huge source of oil in the near future. Even though prices of oil are declining, it’s because of companies like LINE who have increased the domestic production of oil to the point where the US is finally producing more oil than its importing.
What the numbers say
The stock closed yesterday at $26.05, which is a P/E ratio of 17 based on the earnings from 2Q. When looking at earnings, the company broke out of a four-quarters streak of losses, posting a very healthy EPS of $1.46 in 2Q. When looking at revenues of 1Q and 2Q of 2013, they account for 73% of total revenues in 2012. While the company has piled up a significant amount of long term debt and liabilities, it also has a substantial amount of assets as well as hedging abilities in case they ever need them. The big number to take in account though is the last one I’ll mention which is the yield sitting at 11.6%.
Most peoples main argument is that this is an extremely high yielding company at a terrific price. While I cannot agree more on that, my main argument is that the two acquisitions mentioned above can be catalysts to an easy 30%-50% bump in value. Add that value in account and you’ll have a 15-17% yield on initial investment.
If we look at the chart above, the 200-day moving average still prices this stock around 14% above the current price and the 50-day moving average places the stock at around 27% above current price. On top of that, the stock hasn’t seen a substantial amount of trades, keeping volumes relatively low due to the “fear” of the SEC investigation. Another interesting couple of figures on the chart are the price channel values (200-days) that put the stock between $24.51-$39.28.
This is the kind of stock I like getting into for a few reasons: first of all, it’s closer to its 52-week low than 52-week high. Now obviously this is not a reason by itself to buy the stock, but when I look at a stock I try to catch it before a rally, not mid way. All the indicators point that the SEC just needs to finish their meddling, and once that happens the most likely outcome is a positive outcome for the company. BRY’s management have sand more than once that even with these SEC problems, they’re still committed to the deal with LINE. The second reason is the high yield. A company with a double digit yield at a right price that isn’t a REIT or mREIT isn’t easy to find, and with a possibility of 50%+ price increase in the foreseeable future, this double digit yield can get much sweeter than it already is.
Do I recommend buying the stock? it depends. The SEC is known for being notoriously annoying, and they could not allow the BRY merger to happen, or even find things in LINE’s basement we don’t know of… However, this kind of negative mentality can be applied every where in the stock market. LINE has massive amounts of valuable assets, produce a hefty amount of oil and gas, posted good numbers in 2Q and have a 4-5 year plan that once its settled, can be very profitable. If you look at an expanded version of LINE’s chart, you can see a steady value above the $35 mark for all of 2011, 2012 and some of 2013 up to the SEC situation. I believe that once the dust settles, the stock will make a comeback to those levels.
Disclosure: I have no position in LINE. Unfortunately, I am unemployed… and therefore have no capital to invest. If I had capital to invest, I may have initiated a long position in the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with the company whose stock is mentioned in this article.