LinnCo: A Risky Backdoor Oil and Gas Play?

With more than 5,400 stocks to choose from, the universe of investment possibilities is enormous so looking for stocks based on what you already know and own might be a path to pursue.

Motley Fool CAPS, the 180,000 member-driven investor community that translates informed opinion into stock ratings of one to fives, helps you focus your attention by providing you with a personalized Stock of the Day. Using its supercomputer, it looks at stocks currently in your active pick list and then scans stocks picked by highly rated players with lists similar to yours as well as industries in which you currently have active picks, and targets areas in which you already have an interest.

By pairing up the opinions of some of the top investors in the CAPS community, CAPS provides you with a handful of companies on which to begin your own due diligence and research.

Buy what you know
No doubt based on my having weighed in on master limited partnerships like Inergy, Enterprise Products Partners, and NuStar that I rated to outperform the broad market indexes, the CAPS supercomputer thought I also might be interested in LinnCo , a unique business whose sole purpose is to turn complicated distributions from Linn Energy into more easily digested dividends.

It was one of five Stocks of the Day it offered up for my consideration this week, and though it offers a tempting dividend that currently yields over 7%, just remember as smart as the CAPS algorithm may be, it's still just an algorithm. So be sure to look before you leap on any of its suggestions.

LinnCo snapshot

Source: FinViz.com. N/A = not available. Linn Co IPO'd on 10/12/12.

Pipeline to profits
I've written several times about the care investors need to take when investing in master limited partnerships, since they are not all created equally. Although their genesis lies in fixed assets like oil and natural gas pipelines and storage facilities, companies have gotten creative by devising vehicles that stray from the toll road model originally envisioned.

Because MLPs like Plains All American and Kinder Morgan Partners essentially collect fees for each barrel of oil or natural gas passing through their pipeline regardless of its price, their payouts are relatively safe, steady, and secure. But a relatively new breed of MLP has been developed that skews that model, and despite appearing similar on the surface, their payouts represent a greater degree of risk. They're heavily reliant on the price of the underlying asset to make their distributions, because it determines how much they produce.

Linn Energy as an oil and natural gas driller is one such MLP, as is coal miner Oxford Partners, frack sand producer Hi-Crush Partners, and nitrogen fertilizer maker Rentech Nitrogen.

Pencil pushers
LinnCo is yet a different animal altogether. It has no assets; it has no operations. Its sole purpose is to own units of Linn Energy so that it can receive distributions from the MLP and convert them into regular dividends.

MLPs are structured to payout most of there profits to shareholders, and while those payments are nominally dividends, called distributions in this case, and they get special tax treatment and have a whole separate -- and complex -- paperwork regime that needs to be calculated by investors at tax time. LinnCo was created to simplify that process by doing the dirty work for the investor and pay out regular dividends instead, a far simpler transaction for those owning shares. But to invest in LinnCo is to require a close examination of Linn Energy.

Ready for a washout
The drillerhas directed more than half of its capex spending to the Granite Wash, where it's moving all of its gas rigs to oil and has hedged 100% of its oil production through 2016. While the hedging will likely benefit drillers near term as oil prices remain below their highs, Goldman Sachs predicts we're entering a secular period of stable pricing in the $90-a-barrel range that may pressure profits for drillers over the long haul.

Like natural gas, drillers are extracting oil from previously hard-to-reach assets at ever greater rates, and while it's hard to imagine pricing getting pummeled the way gas has, even the investment bank has narrowed its expectations of oil's peak. It now anticipates Brent oil at most averaging $110 in 2013, down from its previous call of $130 a barrel.

Linn Energy looks stable for the time being, meaning LinnCo does too, but investors need to go in with their eyes wide open. I'm not ready to rate the dividend-transfer company as being ready to maintain its outperformance over the long haul, but let me know below whether you are.

More expert advice from The Motley Fool
The surge in oil and natural gas production from hydraulic fracturing and horizontal drilling is creating massive bottlenecks in takeaway capacity. However, this problem for producers creates a massive and immensely profitable opportunity for midstream companies. Energy Transfer Partners helps alleviate the gluts in supply with 23,500 miles of transformational pipelines. To see if ETP and its industry-leading yield will be a fit for you, click on this detailed premium report, which will supply you with a thorough analysis of this midstream.

The article LinnCo: A Risky Backdoor Oil and Gas Play? originally appeared on Fool.com.

Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners and Goldman Sachs and owns shares of Hi-Crush Partners. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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