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How to Trade Linn Energy

Stocks in this article: LINE

NEW YORK (TheStreet) -- When it comes to trading stocks, for some reason it seems easier to buy than to sell. These days, however, investors don't seem to be having any trepidation about dumping Linn Energy (LINE). I think this may prove to be a mistake.

Let's take a look at a stock in the center of controversy, which now sits right at its 200-day moving average.

LINE Total Return Price ChartLINE Total Return Price data by YCharts

Linn has been publicly slammed multiple times over the past 12 months, first by Hedgeye's Kevin Kaiser and then again by Andrew Bary in Barron's (with a strong reliance on Kaiser's research). LINE was in the news again this week as TheStreet's Jim Cramer and Stephanie Link, who co-manage the Actions Alerts Plus charitable trust, cut their position in LINE on Monday and then sold out altogether on Tuesday

For investors, in order for selling here to be a "good" trade depends on what your entry point (or cost basis) was for LINE. 

What if just last week I bought LINE for $32 per share and am down a quick 10%? Do I want to exit the position and take a short-term loss? Or do I want to add to the position and lower my effective cost basis (and improve my effective yield -- LINE's yield as of Wednesday exceeded 10%)?

The answer: It depends.

In the case of LINE, we need to consider whether the partnership's distribution is under pressure. A glance at the chart below shows a very scary picture of LINE's distribution getting cut by what looks like almost 70% last year...

LINE Dividend ChartLINE Dividend data by YCharts

Fortunately there is more to the story. About 8 months ago, LINE began paying out its distribution monthly rather than quarterly (each monthly distribution immediately became equivalent to 1/3 of its respective quarterly distribution at the time). A large part of the aforementioned bears' argument is that LINE can't possibly maintain its distribution -- after all, their distribution coverage ratio is one of the lowest in the business (meaning they have little or no free cash flow after paying shareholders). But why should they? MLPs are pass-through entities.

LINE's distribution coverage has long been the subject of scrutiny; what most critics don't seem to value, though, is the fact that LINE is 100% hedged against commodity price fluctuations. This makes what cash flow they do have extremely reliable. Not to mention that LINE has never cut its distribution since going public in 2006; in fact it has more than doubled over those eight years (from $1.28 to $2.90 per share annually). There is skepticism that LINE may not be able to grow their distribution this year, and maybe not even until late next year. Question: How much would a company paying out $2 per share have to grow its distribution to get to $3 per share? Is that likely to happen in 18 months?

What I see is a company that is focused on growing its asset base and financial strength (through their recent $4.9 billion acquisition of Berry Petroleum), which should provide a greater cushion for its distribution coverage. 

However, there are still reasons to sell LINE here:

a) You need a tax loss;
b) the volatility is simply too much for you;
c) you disagree with everything I have said above. 

I happen to believe the worst is over for Linn Energy and, as such, the reasons to buy it outweigh those to sell. If you already own it, hold on a little while longer before throwing in the towel. 

The reason one person is selling a stock may not necessarily be a good reason for another person to be selling it. In fact, one man's strategic tax loss may be another man's favorable entry point.

-- By Adam B. Scott, founder of Argyle Capital Partners, in Los Angeles.

At the time of publication the author was long LINE.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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