Linn Energy's Price Decline to Accelerate

Attracted to Linn Energy’s (LINE-$10.93) turnaround potential (share price is off 62.5% from its 52-week high) and 11.2% payout ($1.25 dividend/share)? Think again.

In only one of the last four years has LINE been able to cover fixed charges, including dividend payments: Earnings were insufficient to cover fixed charges by approximately $457 million and $696 million for the year ended 2014 and 2013, respectively.

Like operating profits, asset valuations could prove illusory, too. LINE has spent more than $30 billion to acquire working and royalty interests in producing U.S. basins holding total proved reserves of 7.2 Tcfe, allegedly worth an estimated $12.5 billion in (discounted) future cash flows. Allegedly because the calculus driving this valuation assumes natural gas and oil prices of $4.35 MMBtu and $95.27 per barrel.

Given the precipitous decline in commodity prices, investors should expect further massive “non-cash” impairment charges – which could hinder LINE’s ability to finance future capital needs:  buried under $10.3 billion in debt, the company has “limited unpledged assets” to put up as collateral for needed borrowings.

New drilling programs to be funded with capital from Blackstone will do little to clean up LINE’s anemic balance sheet and liquidity issues: Assuming constant capital spending and distributions over the next three years, analysts estimate net debt to EBITDAX ratios could increase to 6.8x by year end and up to 7.1x by year-ending 2016 (as higher priced hedges roll off and cash flow declines).

If LINE is to survive, look for that 11 percent dividend yield to vanish like the value of its hydrocarbon assets.