Who said the market understands hedging?
Linn may be overstating the cash flow available for distribution, by not deducting the cost of financial derivatives—mainly put options—from its realized gains on hedging activities in its quarterly results. Bears argue that funds invested in derivatives should be treated as an expense, and at least one of Linn's major competitors follows that approach.
David Amoss, an analyst at Howard Weil, broke ranks on Friday and downgraded Linn to Sector Perform from Outperform, citing the company's treatment of its hedging costs. Amoss cut his estimate of 2013 distributable cash flow to $2.45 per unit from $3.03, "to better reflect the underlying cost of the hedges" that he estimates at $120 million annually, he wrote in a client note. Linn might have to make accretive acquisitions this year to cover its $2.90 distribution, he added. Alternately, it is possible the distribution could be cut.
Linn expenses the cost of puts and other derivatives over a multiyear period when calculating net income, as mandated by accounting rules. But it doesn't deduct such costs from distributable cash flow, a financial measure that isn't compiled in accordance with GAAP, or generally accepted accounting principles. This means companies have leeway in making the latter calculations. Usually, they subtract interest expense and maintenance capital expenditures from gross cash flow to derive the amount of cash available to be distributed to holders.
At the very least, Wall Street should start asking harder questions about what Linn calls its "industry-leading hedge program."
This #$%$ me off.
Let’s start here. “Linn expenses the cost of puts and other derivatives over a multiyear period when calculating net income”.
So, the expense is already in the Net Income from Continuing Operations number.
Here’s what the company has to say about Adjusted EBITDA.
Adjusted EBITDA is a measure used by Company management to indicate (prior to the establishment of any reserves by its Board of Directors) the cash distributions the Company expects to make to its unitholders. Adjusted EBITDA is also a quantitative measure used throughout the investment community with respect to publicly-traded partnerships and limited liability companies.
The Company defines adjusted EBITDA as:
1) Income (loss) from continuing operations, (Remember, the amortized put and derivatives expense is already in this number)
plus the following adjustments:
2) Net operating cash flow from acquisitions and divestitures, effective date through closing date;
3) Interest expense;
4) Depreciation, depletion and amortization;
5) Impairment of long-lived assets;
6) Write-off of deferred financing fees and other;
7) (Gains) losses on sale of assets and other, net;
8) Provision for legal matters;
9) Loss on extinguishment of debt;
10) Unrealized (gains) losses on commodity derivatives;
11) Unrealized (gains) losses on interest rate derivatives;
12) Realized (gains) losses on interest rate derivatives;
13) Realized (gains) losses on canceled derivatives;
14) Unit-based compensation expenses;
15) Exploration costs; and
16) Income tax (benefit) expense.
So, the expense is in the distributable cash flow number. It’s an amortized expense number as opposed to a cash expense number, and therefore there will undoubtedly be a mismatch between when cash is actually paid to purchase hedging derivatives and when those costs flow through the income statement. This runs both ways, in periods of heightened hedging activity cash costs will exceed expenses running through the income statement; in periods with little relative hedging activity expenses will exceed cash costs. This is why GAAP allows expensing over a multiyear period to smooth out the impact on the company’s financials. Also, in the above paragraph on Adjusted EBITDA, notice the reference to reserves, reserves are established to smooth the mismatch between cash and amortized costs in the calculation of distributable cash flow.
What a joke that this moved the stock.
I would like to agree with you but doesn't line 4 contain the word "amortization" which leads me to believe that although it's expensed in calculating net income amortization is added back in when calculating Adj. EbitdA .If Line would leave out the word "amortization" in line 4 of the items that are added back in you would be correct.Not trying to be critical and would appreciate your reply .Thank You
The put expense issue is indeed funny...but I suspect we will receive A LOT more detail either during the conference call, or a much more detailed presentation.
I have a feeling we will be hearing a lot of questions on how they account for their hedges in the Q&A session.
So, my concerns with Linn have centered on several items:
One, as Linn's hedges roll off the books, they have had to continue to layer on hedges at much much lower prices. This has compressed their margins. This has necessitated massive acquisitions to plug holes in the DCF. You can't make acquisitions 5 yrs ago when gas was $10/mcf and lifting costs are $2.50/mcf and then expect to maintain the same margins when your realized price is now $5.50/mcf. The simple fact is, without acquisitions over the past 3 years, Linn would not have covered the distribution.
My second issue has been their lack of following through on statements like achieving $.02/unit of distribution accretion for each $100 million in acquisitions.It doesn't require a lot of math skill to see that they have not achieved anywhere near $.02/unit accretion per $100 million spent on the $5.7 billion in deals they have made over the last 3 years UNLESS you realize that that new cash was simply plugging holes.This issue coupled with fact that they never were able to achieve the kind of growth they projected from the Granite Wash (not Hogshooter). They made a lot of projections on per well accretion that clearly never materialized..in part because they did not hedge their NGL exposure but also because they took the easy way out by buying in bulk rather than having the patience to develop their acreage one well at a time.What resulted was dillution of the per unit exposure to the GW, Hogshooter etc. If the rates of return are so good..no management team would dillute such returns....
These of course are separate issues than the capitalizing or expensing of puts.
"One, as Linn's hedges roll off the books, they have had to continue to layer on hedges at much much lower prices. This has compressed their margins. "
Wrong again. The primary causes for the stall in DFC were cost inflation before our natural gas industry went dead. Then the over supply of light ngls and crashing prices. As every one else understands the futures markets for ngls are not efficient and are often in backwardization.
This is a margin business. Yes natural gas prices five years out are about $4.50. But what is also important if the actual cost of production and handling. There have been significant investments in gathering and water handling assets. Also demand inflation is gone and replaced by industry wide 30% reductions in drilling costs.
You can keep typing the same old sorry nonsense but repetition will not make it accurate.
I wounder what silliness you will type if the Raymond analyst is correct and coverage comes in at 1.2? Given the results out of GW a nice shift to oil and heavy liquids production the other gas EPs attempted is most likely the reality. Along with some sizable over all volume gains.
NG production and consumption are closing on a very weak economy. Obama negative growth in the forth quarter and ng is the cyclical economic energy. Sooner or later Obama retires and American can achieve at least average economic growth or the collapse in dry rigs/light ngl drilling along with shale decline rates will adjust to the new sad Obama normal. Ngas prices will have to rise at least to the marginal cost of production plus the one approved natural gas facility can move a meaningful amount of gas.
So do we congratulate management for long term strategy or get on the horse backward and confuse past cost inflation in a boom and then the resulting collapse in light ngl prices as reoccurring events?
We will see.
LINE couldn't hedge their NGL exposure because it is to hard to predict down the road. Therefore as you stated they did dirty hedges and only on propane and ethane. I was told this in an email back to me when sand challenged that their hedging of NGL's was on going but onlyon the deal with BP. So all this talk about hedging NGL's is worthless. By playing puts on other hedging i beleive is finaly catching up to them. They will have to roll out of those as well. Thye may hedge different but it is more sloppy hedging then anything. As you mentioned the hedging years out is dropping in price.
Ok This Amoss clown initiated out perform on January 23, 2013 and then February 14 2013 did this noisy downgrade based on this. So what caused the change in the hedge book in less than a month. The analyst did not understand three weeks ago then learned and saw the light? ;-)
Guess there is an RLP'D born to be a sucker.
Wall Street analysts have ignored the derivatives issue until now. Thirteen of the 18 analysts who follow the company rate it Buy, and bulls note that Linn's energy production, including oil, gas, and natural-gas liquids, more than doubled in last year's third quarter, to the equivalent of 782 million cubic feet per day.
Even this is pretty funny. The drilling effort is HOgshooter/Granite Wash. OIL. So why would it be left out? ;-)
Nope there is more than this running around the rumor mill.
I don't totally understand LINE hedging strategy, but let me put Barrons in perspective. A couple of years ago they ran an article that headlined something like this "Can Bank of America go to 2.50" we all know how that turned out.