A 9.8% Yield For Enterprising Investors

Mar.11.14 | About: Goodrich Petroleum (GDPM)

Summary

GDP-D trades at a slight discount to its issue price and yields 9.8%.

GDP is a speculative oil and gas firm and this is a high risk, high reward preferred issue.

The 9.8% yield is tax-advantaged for investors seeking current income.

The oil and gas industry is littered with speculative firms that engage in the exploration, development and production of fossil fuels. These firms are often highly levered and have unpredictable revenue streams and commensurate with that shortcoming, a lack of profits. One such firm is Goodrich Petroleum (GDP), a $660 million market cap firm founded in Texas in 1995 with about 100 employees and working interests in 436 producing oil and natural gas fields in the US. The company does have $435 million in long-term debt, which is around two times annual revenue, but also sports a tangible book value of more than twice its current market cap. In this article, instead of taking a look at the volatile common stock, we'll take a look at a preferred issue from Goodrich that could put significant income in your portfolio provided you can stomach the risk.

The issue in question is Goodrich's Series D Cumulative Preferred Stock (GDP-D, could differ depending on your broker). GDP-D is a traditional preferred stock issue, meaning it has no debt issue backing it and has no stated maturity. The issue pays regular quarterly dividends of 61 cents per share and based on the issue price of $25, the coupon yield is 9.75%. Given the current price $24.81, the current yield is a bit higher than the coupon at 9.8%.

GDP-D has no stated maturity date but it does have a provision in it that allows GDP to call it at the full issue price of $25 beginning late in 2018. Should this occur, holders will receive $25 per share regardless of where the issue is trading at that time. As a result, anyone that buys today and then gets called away will be entitled to receive a very small capital gain on their position. With the issue trading very close to its issue price it isn't one you buy for capital appreciation, however; you buy an issue like this for the income.

Speaking of the income, dividends on GDP-D are cumulative, meaning that barring some kind of bankruptcy event, GDP-D's distributions are guaranteed. Even if GDP misses dividend payments on GDP-D, it is required to make them up. This is a major perk of investing in preferreds; common stock dividends have no such guarantees and on income that is very close to 10% yearly, that is a nice feature to have.

GDP-D's distributions are also eligible for the preferential dividend tax treatment, 15% for most investors, so it is tax-advantaged as well. Even in a taxable account at the full 15% rate this issue still provides ~8.5% in after-tax yield, making it one of the strongest on the preferred market. Of course, holding GDP-D in a retirement account is preferable as it defers all taxes.

I'd be remiss if I didn't mention the reason the yield is so high on GDP-D and that is default risk. GDP is a speculative oil and gas firm and one must understand this before pulling the trigger on GDP-D. This is not a preferred you can buy and forget about; holding GDP-D takes constant monitoring of GDP's business and financial condition. This issue is rated as Caa2/CCC-, meaning it is junk-rated. However, you are being compensated for that risk with the very high yield; you just have to make sure you understand the risks fully before entering a position. Due diligence is paramount on this issue in particular and should not be skipped.

GDP-D offers enterprising investors the chance to own a preferred that yields very close to 10% and is trading at a slight discount to its issue and call price. While there is no mistaking that this is a high risk, high reward preferred, it can still have a place in your income portfolio. Please, before taking any action on GDP-D, understand the risks of owning preferred stock in a small, speculative oil and gas firm as there is the chance it could eventually run into liquidity issues. While dividends are guaranteed on GDP-D, it doesn't mean GDP will necessarily be able to cover them forever. GDP-D can provide you with very nice income and there is no threat of GDP defaulting right now but this is a buy and monitor security, not buy and hold.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.