Linn Energy Gaining Power as the Bad Headlines Fade Away

NEW YORK (TheStreet) -- Linn Energy (LINE) is no stranger to bad publicity. But its stock seems to be recovering after the company was hit with accusations about its accounting methods last year and then a bearish Barron's article earlier this year.

The master limited partnership's stock currently trades around $29.80, down 3.3% for the year to date and nearly 10% for the past 52 weeks.

Back in March I wrote an article about how Linn was "walking the line" of risk versus reward. At the time we were reading one negative headline after another about Linn, though most of the information stemmed from 2013 accusations by Hedgeye's Kevin Kaiser about Linn's financials. These accusations were later deemed to be without merit.

After an SEC investigation, Hedgeye contended, Linn's $4.9 billion (and immediately accretive) acquisition of Berry Petroleum would be at risk. The stock promptly fell from nearly $40 to the low $20s. It gradually recovered up to about $34 early this year.

Then Barron's came out with a bearish article, leveraging Hedgeye's research to conclude Linn was still overvalued. Barron's argued the then-ongoing SEC investigation would almost certainly turn up something fishy about how Linn was calculating its distributable cash flow (from which it pays out distributions). The stock fell once more, from $34 to about $28.

The Berry acquisition has since been completed after the SEC gave Linn a clean bill of health from an accounting perspective, and the stock has stabilized. The question now becomes how much of the Hedgeye- and Barron's-induced drop was warranted.

From the technicals illustrated below, we can see a bullish pattern finally emerging for Linn as its shorter-term moving averages cross above its longer-term moving average:

LINE Chart


Back in March, Linn was trading at $29 -- as of this moment it is getting closer to $30, a move of about 3% in price. But don't forget we have also been collecting nearly 1% per month in distributions. Let's call it a 5% total return. Not particularly exciting but in line with the 4% return from the S&P 500 over the same period. What looks to be a fairly strong floor may have formed for Linn's shares.

As Linn's price has dropped last year, the corresponding spike in yield (pictured above) was fairly dramatic, since the distribution remained intact. Provided there is no immediate threat to Linn's distribution -- which hasn't been cut since the company went public in 2006; in fact, it has nearly doubled -- it seems there is a limit to how inexpensive its shares may get.

Also supporting the idea the stocks might've found a bottom, just two weeks ago it completed an asset swap with Exxon Mobil (XOM) that improved Linn's cash flow without issuing any new debt or equity.

Below you can see the behavior -- both yield and price -- for Linn Energy over the past two years. Appetite for LINE's beefy distribution puts downward pressure on its yield and upward pressure on price.

LINE Chart

Generally speaking, a master limited partnership trades based on the spread between its distribution yield and the yield on the 10-year Treasury. That spread will differ from MLP to MLP as each company carries unique risks for which an investor must be compensated.

Among others these include: the sustainability of its distribution; amount and cost of the company's debt load; diversification and quality of the MLP's assets; and forward-looking interest rate expectations. In the case of Linn, that spread is north of 7% (700 basis points) today, historically high for its shares.

Now that the patient is stabilized, our view is there is a good deal of room for that spread to shrink -- a 700-basis point spread implies an enormous amount of risk. There are three ways this can happen. The 10-year Treasury yield could spike, LINE could cut its distribution oran upward move in the stock price, whereby LINE's effective yield would come down. I think option 3 is the most likely at this point.

If the spread were to narrow from 7% to 5%, for instance, the implied price of LINE units is about $36. That's 20% higher than today's price. Along with a 10% current yield, the total return opportunity remains quite attractive.

We think it's worth walking the LINE.

At the time of publication the author had a position in LINE.

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

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