Earlier this month, Goodrich Petroleum (GDP) issued a $100 million worth of perpetual preferred stock. The preferreds carry a 10% yield. A nice yield that many income investors would salivate at. However, I believe this is something that you need to stay away from, no matter how nice the dividend stream is.
To understand why this is a very poor investment choice for income investors, we need to examine the company's ability to pay the preferred. Since it's 10% at a $100 million offering, the yearly distributions will be $10 million. Can the company afford this?
Well let's take a look at Goodrich's cash flow over the past three years. In 2010, the company had negative FCF of nearly $164 million. In 2011, it was nearly negative $200 million. In 2012, it was negative $80 million. This is simply the cash flow related to operations. The company has also consistently paid over $6 million in distributions through private offerings.
While it's possible Goodrich could lower its losses, the company needs to earn a profit. Given its outlook, I don't see this as a very likely scenario. Natural gas prices are likely to remain low for a very long time, and given how deep the losses are, it would take quite a rise for the company to breakeven.
So does this seem like a preferred you could invest in?
I see no ability for the company to even pay for this debt. The best way to think about it is to understand the current interest rate environment. Most of you know that getting a decent yield on an investment grade security is laughable. Junk debt is yielding 4%-6% as everyone chases yield.
So with Goodrich issuing a 10% yielding preferred, it must really say something about the quality of the company. It's also important to note that many investors haven't really seemed to jump in on this yet. The preferred is trading at only a 6 cent premium. Maybe it's because people realize how unappealing the offering truly is.
I had to make sure income investors did not fall for this trap because it's simply not worth it. One last point is that the preferred is non-cumulative, so they can essentially stop payment and there would be no repercussions for them. Don't fall for this trap.