Vanguard Natural Resources (VNR) specializes in acquiring and developing oil/gas properties. The company has a market cap of nearly $2 billion. They also pay a dividend of 9%, which is very tempting. Just recently, Vanguard issued a new preferred onto the market with a yield of 7.875%. The company will raise about $53 million after expenses for paying down their revolver and other debts.
Given that preferreds are senior to the common, it does make sense that the yield would be lower. However, I don't believe the preferred to be a good opportunity. The reason is clearly written in the prospectus.
Unlike most preferreds, Vanguard can dilute the Series A securities.
From the prospectus:
The Series A Preferred Units are subordinated to our existing and future debt obligations, and your interests could be diluted by the issuance of additional units, including additional Series A Preferred Units, and by other transactions.
"The issuance of additional units pari passu with or senior to the Series A Preferred Units would dilute the interests of the holders of the Series A Preferred Units, and any issuance of Senior Securities or Parity Securities or additional indebtedness could affect our ability to pay distributions on, redeem or pay the liquidation preference on the Series A Preferred Units. Only the Change of Control provision relating to the Series A Preferred Units protects the holders of the Series A Preferred Units in the event of a highly leveraged or other transaction, including a merger or the sale, lease or conveyance of all or substantially all our assets or business, which might adversely affect the holders of the Series A Preferred Units."
- S12 of the Prospectus
So the prospectus clearly states dilution is a possibility. This is not very appealing to income investors since the reason is that preferreds are meant to be stable securities with fixed yields. As a preferred investor, this doesn't make me want to purchase the securities.
The other issue is simply the fact that the company is not making the money to take on debt. Last year, the company lost nearly $630 million in free cash flow. Many of you might say that this loss could have been mainly due to a $270 million non-recurring expense. However, even in 2010, the company reported a negative free cash flow of nearly $60 million.
One of the main pieces of information that preferred investors need to look for is the company's ability to pay the preferred. If the company can't even make positive cash flow to cover those dividend payments, then chances are the company will run into a liquidity crunch into the future.
Given that the preferreds yield 7.88%, I don't believe the dividend payments are indicative of the actual risk that exists. Natural gas prices are still very low and likely to remain that way due to the large amount of supply that exists.
I am never a fan of chasing yield in this environment. We know at some point that rates will rise so we have to best manage our risk profiles going forward. My last article talked about First PacTrust BanCorp (BANC) and its new preferred, which has an 8% yield. I discuss that this preferred is good because the company is using the additional cash for growth and BANC is still a profitable bank.
I urge investors to be cautious on VNR's new series A preferred. The mix of a possibility of dilution and a lack of profitability requires more than a 7.88% yield. Do not chase yield.