Finding a high yield is not normally an issue, but finding one that doesn't force investors to take on a whole lot of risk is. We all want a higher yield on our portfolio. It's simple because a larger dividend will mean greater compounding over time. However, we need to be careful here because given such a low rate environment, investors would have to take greater risk for a moderate yield.
Given that many investors are chasing yields, companies with poor earnings have been able to issue relatively cheap debt onto the market. This brings me to Miller Energy Resources (MILL), which is an O&G company with a market cap less than $350 million.
Miller Energy got my attention after it issued its series D preferred last month. Miller also has another preferred, the series C, which still hasn't been called yet. The series D has a yield on cost around 10.7%. This is a pretty nice yield, but given the low rate environment there may be more to the story.
One of the reasons why I find this preferred unique is that it floats in 2018. Also given that the underlying company is somewhat riskier, the spread for floating is fairly large. The spread is three month LIBOR + 907 bps. This is a strong spread, but it makes sense if we look at the underlying cash flows.
In FY 2012, Miller had lost nearly $50 million in free cash flow. In the same period, the company took on $50 million in long-term debt. Miller has been to maintain its overall positive to breakeven cash flow due to financing. Remember that Miller issued its series C last year, which helped net the company about $17 million in proceeds. While its good to have access to the capital markets, it can be an issue if the operations do not become profitable in the long-run.
The dividends for the series C and the D are costing the company $4.4 million. This is quite a chunk of money for a company of this size. Now this doesn't mean that the company shouldn't have financing in place. It's good for a company to get financing, but we need to look at it from the point of the income investor here.
Based on the company's growth, it doesn't seem like free cash flow will go positive anytime soon. This presents a problem for preferred holders here because the company will essentially have to use the $32 million cash on hand or have to issue more equity and debt.
So this is not exactly a preferred I would recommend to most investors, but for those that are willing to take risk, it could be a profitable play. Why is that?
Well while I don't really see the company turning to profitability right now, there may be a point when it does. The total interest and the combined dividends from both preferreds is costing the company around $11 million a year.
So the company has $32 million in cash, which includes the $25 million in proceeds from the series D issuance, might help keep the company running until it becomes profitable.
Revenue for the company has been rising steadily. For the July quarter, the company had revenue of $13 million and a gross profit of $6.4 million. Last July, revenue was $8.26 million. This is a 57% growth in revenue year over year.
If the company can keep margins up by minimizing gross profit, this preferred could be a great investment. However, investors need to understand that this may not always pan out how you want it to. It is always possible that the earnings could deteriorate and the liquidity runs dry.
This is a high risk preferred investment not for the faint of heart. If the company returns to profitability, it would mean investors get a 10.7% yield with a possibility of going floating in 2018.
Note: The Miller Energy series D has different names for various brokers. Some examples are MILL-D, MILL-PD, MILL PRD, etc. Please check with your brokers regarding this.