Linn’s prospects. The stock has an 11.6% yield and has been beaten up over the past few months, offering investors the possibility of getting in at a bargain.
One of the reasons the stock was hammered is the concern that Linn’s dividend is unsustainable.
Every Wednesday, in Wealthy Retirement, I write a popular column called the Safety Net. Each week I look at the dividend safety of a stock (suggested by a reader) and assign it a rating of A through F. It’s not a prediction on the direction of stock price, but a rating on whether the dividend is sustainable.
Let’s do the same for Linn in this column.
The first thing we do when examining an MLP is look for distributable cash flow (DCF). Since MLPs are required to send 90% or more of their earnings to shareholders, we want to make sure the company’s DCF in fact covers the distribution. Keep in mind, earnings are not the same as DCF, which is why we want to be sure that there is enough DCF to pay the distribution.
If we look at the company’s most recent 10-Q filed in August, we see that for the first six months of the year, the company paid out more than it took in in DCF. That’s not good.
In the first six months of last year, the company generated over $18 million more in cash flow than it paid out. This year, it’s $38 million in the hole.
Houston, We Have a Problem
The Houston-based Linn has another issue that may be worse than the $38 million shortfall.
In September, the company all but admitted its accounting was misleading when it changed the way it accounts for critical figures such as distributable cash flow and adjusted earnings before interest, taxes, depreciation and amortization (EBITDA).
According to analyst James Kostohryz, the company will stop using terms the SEC thought was misleading. Instead it will make up terms such as “discretionary reductions for a portion of oil and gas development costs.”
Kostohryz says this means “Linn will set the level of cash flow that it believes is distributable to shareholders at whatever it pleases in accordance with its discretionary definition of (a portion of) oil and gas development costs.”
He adds that the company will no longer use accepted accounting rules to report distributions, but will instead reverse engineer the costs in order to achieve the desired distribution.
So we have a situation where, under its old accounting procedures, the company did not generate enough cash to sustain the dividend. And now its new accounting policy appears to be unreliable and perhaps not an accurate indicator of whether the company can continue to pay its dividend.
As I said, I grade the safety of the companies’ dividends A through F. The table below describes what the ratings mean.
Considering Linn’s problems, I suspect the distributions will be lower, which will not be music to shareholders’ ears.
Dividend Safety Rating: F