High-Yield Preferred To Be Thankful For: Undervalued, High Yield, Inflation Linked

| About: GeoMet, Inc. (GMET)

Around the Thanksgiving holiday, there is much to be thankful for, despite the post-election pullback in the stock market and negative post-election economic news. One thing I am thankful for is a position I am holding that seems to offer investors much of what they are looking for in this environment. Particularly yield (the more the better!), inflation linkage (if there's inflation from QE-infinity, yield instruments could trade down) and undervalued (more potential for capital appreciation).

That position is Geomet Preferred (GMETP). GMETP pays a 12.5% yield, and pays it in kind. At the current $5 price, it is trading at half of par. So the effective yield assuming a par recovery is 25%, which is unusually high and certainly something to be thankful for.

Geomet Preferred (GMETP) is inflation linked via its conversion feature into Geomet common stock (NASDAQ:GMET) at $1.30 per common share. GMET is far from $1.30, but it is highly levered and inflation linked, which makes this potential for conversion quite attractive. Geomet had $173 million of proven natural gas reserves as of the end of 2011, assuming a natural gas price of $4.21 (roughly equivalent to the forward price of natural gas for the next couple years). That value is highly sensitive to natural gas prices - if there is considerable inflation, or if any one of the numerous articles about natural gas being poised to rise are correct, that value could grow considerably and could lead to GMETP trading at a premium to par, potentially up to $20 at a $6 natural gas price. This inflation linkage helps preserve GMETP's value, because in such a scenario it is possible interest rates will have risen and other yield instruments will have traded down.

And finally, Geomet Preferred (GMETP) seems undervalued on several different measures. It pays a higher than normal yield, and is hedged for the next 18 months, which should ensure it will continue to pay that yield going forward. Also, looking at the proved reserve value ($173 million) versus the amount of long term debt ($130 million), there is more than enough reserve value to cover that debt plus cover the preferred at $10, and it is currently trading for $5! This high yield with potential for capital appreciation and reserve value backup certainly seems to offer compelling value versus other yield alternatives.

It is worth mentioning a comparable yield product to highlight GMETP's attractiveness. One example is Magnum Hunter's (MHR) Preferred Series C, which trades slightly above par and pays a 10.25% yield at par. It is not convertible, and if a similar calculation is done comparing Magnum Hunter's debt versus its proved reserves, there is less coverage than GMETP has. (That calculation is complicated by MHR's acquisitions, development and additional debt this year since its reserve report, but it holds true.) So with MHR-PC, an investor gets less yield, what appears to be less value, and no conversion feature to provide inflation protection.

Another comparable yield example, which is different due to structure but is a common security held by yield seeking investors who are sensitive to inflation is Linn Energy (LINE). Linn is a great company with fantastic management, and has done an excellent job paying a growing dividend to its shareholders. However, its current yield is only 7.4%, and LINE shares don't have a liquidation preference like GMETP and MHR-PC. Obviously LINE is far more liquid, but perhaps it is worth investors stepping into a less liquid security for almost twice the current yield and potentially almost 4x the yield assuming GMETP trades up to par value.

For some background, Geomet is a small natural gas company that produces from coal bed methane fields primarily in Alabama, Virginia and West Virginia. Geomet is fully hedged for the next 18 months. Geomet had an issue with its bank group when natural gas prices fell below $2 earlier this year, at which point both GMET and GMETP fell off a cliff. Since then, Geomet has mostly resolved its issues with its bank group, helped by its strong hedge position and by natural gas prices recovering. And importantly, Geomet is a micro-cap company and is more risky than larger, better capitalized companies.

Disclosure: I am long GMET. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am also long GMETP