Understanding preferreds may be simple, but it can get much more complex when trying to analyze the underlying company's ability to pay the dividends.
Tsakos Energy (TNP) released a new preferred offering at the beginning of May. The preferred has a yield of 8%. This is a fairly decent yield, but how has the entire company fared lately.
The total offering amount is $50 million. So an 8% yield means the company will have to pay around $4 million in distributions yearly. Doesn't seem so bad for a company that made $60 million from operations in 2012, right?
TNP is unique because while it does produce a decent amount of cash flow, the cost of capital expenditures have caused it to report negative free cash flow. However, there may be a bright side to this. The negative free cash flow has fallen over the past three years from losing nearly $300 million to just $24 million. The company still has about a $145 million of cash on hand as well.
Besides lowering losses and a large amount of cash on hand, another reason why I believe Tsakos could be an interesting play is because management has cut the excessive dividend payments that used to exist. Last year, the company cut the quarterly dividend to 5 cents from 15 cents. In addition to this, Tsakos seems to have pushed back its current dividend that was due in Q1.
So the company does stand to save more than $10 million each year through the mix of cuts and suspensions. While these cuts and suspensions may concern those looking to invest in the preferreds, I believe they are necessary. The current 5%+ yield seems heavy for a company with negative free cash flow. In fact, investors looking to invest in the preferreds should take comfort in that the company is choosing to save money.
Finally, Tsakos has placed a unique provision in place in order to calm preferred shareholders. Under the Failure to Redeem or Dividend Default covenants, the company is required increase its dividend to 10% from 8%. So if the company happens to miss one quarterly payment, this would result in a dividend payment default. If TNP fails to redeem all of its preferreds on or before July 30, 2019, this would result in a covenant breach. This would mean the dividend would rise to 10% as well.
TNP's preferred B provides a unique opportunity to receive an 8% yield on a company that is cutting expenses and has plenty of cash on hand. It's likely the company could break even soon and with the preferred covenants in place, income investors could be at ease. I believe TNP series B provides income investors a decent yield if they are willing to take on a moderate amount of risk.
One last note, please be aware the preferreds are trading above par. I am not a huge fan of overpaying especially on a preferred like this. I recommend investors wait to get it slightly closer to par.