Linn Energy LLC (NASDAQ:LINE) is a favorite among dividend stock investors right now who are looking to bargain hunt in the energy sector.
Thanks to crashing crude oil prices, LINE stock has plummeted 70% over the past year … and as a result, many screens for high-dividend stocks show Linn Energy LCC at or near the head of the pack thanks to big payouts and a depressed share price.
However, my favorite saying about dividend stocks is that the quickest way to double a company’s dividend yield is to simply slash the stock price in half — and income investments like LINE with big yield often hold big risk thanks to substantial downward momentum.
So should investors consider a bargain buy in Linn Energy, or should they steer clear?
I think the latter.
Linn Energy Dividend Isn’t Sustainable
First, consider that the headline dividend yield you get on many financial websites is not the real yield for investors going forward.
In the case of Linn, if you’re calculating dividend yield based on previous payouts, you’re fooling yourself. In January, the company slashed its monthly dividend from more than 24 cents to just over 10 cents.
That payout is monthly, of course, so the bulls like to point to the juicy yield of more than 12% at current pricing as plenty of incentive to buy even if things are volatile.
But more important than the total dividend yield for LINE stock is the payout ratio — which is wholly unsustainable. Even after the dividend cut, Linn Energy can’t cover its distributions.
That’s because it doesn’t make a penny in annual profit, and hasn’t since fiscal 2011.
Sure, it’s easier to pay out about $1.25 in annual dividends vs. almost $2.90. But if your earnings are zero … the math doesn’t work either way.
Also remember that the 12% yield on paper is based on a full year’s worth of distributions. If you only get three months of dividends and the company, say, suspends its dividend … well, you’re only getting a 3% yield instead.
Given the volatility for LINE stock, there is a high likelihood of much more than a 3% drop in share prices — offsetting any potential profit from this trade.
LINE Stock in Deep Trouble
Most disturbing to me is not the dividend cut or even the big flop in share price for LINE stock over the last year.
The biggest issue investors should watch right now is the balance sheet, which shows a growing debt load that will continue to hamper any profitability.
At the end of 2010, Linn had $2.7 billion in total debt … and at the end of last year, it had $9.1 billion. While revenue has indeed soared since then, providing debt service on those obligations even as crude oil crashes is going to keep pressure on LINE stock in 2015.
Furthermore, when an energy exploration company like Linn finds itself strapped for cash, it naturally cuts back on investments in new oil and gas fields. This will depress future earnings even if energy prices stabilize in 2015.
It all adds up to a very risky stock that has nothing to offer but a big yield on paper but the risk of future cuts in your distribution.
I would steer clear of LINE stock for now despite the big-time dividend yield. Investors who think Linn Energy is worth bargain should take a good look at the balance sheet and not just the shaky potential for income.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.
