A 10% Monthly Yield That Investors Should Avoid

| About: Enerjex Resources, (ENRJ)
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Summary

EnerJex's new 10% yielding preferred may entice investors but the company is putting itself at risk.

EnerJex's high leverage should concern preferred investors.

The company has negative free cash flow making it difficult to make its preferred payments.

EnerJex Resources (NYSEMKT:ENRJ) is a small cap oil and gas E&P. EnerJex owns oil and gas leases over a 100,000 acre area spanning over four states. The company is a small cap with a market cap around $52 million.

EnerJex recently just issued its new series A preferred. The preferred yields 10% at par value. EnerJex raised $15.2 million in gross proceeds from this offering. The company plans to use the proceeds for further development of its O&G properties in Kansas and Colorado.

While it's good to see EnerJex is expanding, the problem is that the company is trying to grow too fast and has already begun to have cash flow problems. In FY 2013, EnerJex had cash flows from operating activities of $3.1 million. However, it had a capex of $7.85 million. In the last three years, the company has had negative free cash flow.

The fact that EnerJex is spending on capex is a good thing. Small O&G companies usually have negative free cash flow in the early stages due to expansion. The problem is that EnerJex's need for quick growth is causing the company to take on excessive amounts of debt.

For 1Q2014, the company reported total cash of $1.4 million and debt of $32 million. From 2Q2013 to 1Q2014, debt has ballooned from $11 million to $32 million. The amount of leverage is likely to increase over the next couple of years.

Now with the new preferred that's been issued, the company will have to pay the additional borrowing cost on that. This will cost the company around $1.5 million a year in dividends that have to be paid to preferred holders.

In my previous articles, I have mentioned that investors need to be cautious with double digit yields in this environment. The lack of attractive yield opportunities is continually causing investors to take on more risk. I believe this situation is no different.

I think EnerJex was actually able to lock in an attractive preferred yield given the company's risk. The company is taking advantage of this low rate environment. From a corporate standpoint, it's a good move on their end, but we need to look at this from an investment standpoint. I believe this preferred is simply not an attractive opportunity. The company's high leverage and lack of free cash flow will make it difficult to meet the preferred distributions in the future.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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