Earn 10.5% Yield To Maturity With Ion Geophysical's 2021 Bonds

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About: ION Geophysical Corporation (IO)
by: Jeremy LaKosh
Summary

Ion Geophysical's earnings report sent the stock price higher and the bond price lower.

The company's cash generation was impaired by increased receivables, which should help its 2019 performance.

The threat posed by litigation remains but is not certain.

Ion Geophysical (NYSE:IO) reported solid fourth quarter earnings last Wednesday. The company's revenue and EPS beats sent the stock rallying by more than 20%. Despite the rise in share prices, the company's 2021 bonds dropped in price from the high to mid-90s. At the current price of 96.5 cents on the dollar, combined with a 9.125% coupon, the bonds yield 10.5% to maturity. A deeper look into Ion's financial performance and outlook should help fixed income investors determine if their high yield bonds are a good investment.

Source: FINRA

2018 was a challenging year for Ion Geophysical, mainly due to the continuing volatility in the energy markets, which the company serves. Revenue, gross profit, and operating income each declined in 2018 versus the previous year. A substantial portion of the company's operating loss came from the non-cash write-off of long-term assets. Not including the asset impairment, the 2018 operating loss still exists, but less than $10 million off 2017 and better than 2016's results.

Source: Company 10-K

Ion Geophysical's asset impairment was one of two notable changes to the company's balance sheet in 2018. The asset impairment accounted for 75% of the company's total net property assets. Fortunately, the impairment was offset by a $40 million decline in long-term debt. The company's current assets now exceed the value of its long-term debt, a plus for bondholders. Nonetheless, the company did have a decline in equity for 2018 as other fixed assets also saw declines in value.

Source: Company 10-K

As for cash flow, Ion Geophysical did see a decline in operating cash flow in 2018. Part of this decline was due to the company's build in receivables (also briefly mentioned in the earnings conference call). The receivables build should be positive for operating cash flow in the first quarter. The company, despite the drop in operating cash flow and negative free cash flow, was still able to reduce debt by $40 million during the year. The company used a combination of cash on hand and a $47 million equity offering to cover capital expenditures and debt reduction.

Source: Company 10-K

With the cash payoff of notes due in 2018 and the paydown of its revolving credit facility, Ion Geophysical's debt structure is far simpler. The 2021 notes are the only significant debt remaining and, despite being second lien, are currently first in line to the rest of the revolving credit facility. The interest expense of the 2021 notes is $11 million annually, a $2 million decrease from 2018.

Source: Company 10-K

Since the company does not provide forward guidance, forecasting the financial outlook as it relates to cash flow is somewhat trickier. In the earnings call, the company mentioned a boost in operating cash flow related to increased receivables and an industry expectation of 8% in E&P spending in 2019. By combining 2018 operating cash flow with the increase in collections from receivables, the interest savings, and 8% growth, investors can expect the company to generate $25 million in operating cash flow in 2019.

While the cash flow forecast does not project positive free cash flow in 2019 or 202, the company is carrying enough cash to get through those years without needing additional financing. The projections also include $30 million in capital expenditures, which is a historically high figure. Ion Geophysical will need to refinance its 2021 maturing debt when the time comes, but the company may be able to pair its debt down to under $100 million at that time.

One risk the company faces that is external to economics is litigation. Last year, litigation involving the company's intellectual property and use of patents was argued before the U.S. Supreme Court. While Ion Geophysical did not come out favorable in the decision, CEO Brian Hanson spent some time discussing the case in the company's earnings call. Essentially, the case has not ended yet as the Patent and Trademark Office's ruling in 2015 regarding four of the five patent claims may negate compensation. It is possible for litigation to be ongoing after the bond's maturity date.

Overall, I believe that Ion Geophysical's bonds are a great addition to any high-yield investors portfolio. The company's debt reduction strategy in 2018 brought the number of debt accounts from three to one. The company's slight free cash flow deficit is offset by its cash balance and hopes that the energy sector will stage some type of sustainable rally in the future.

CUSIP: 462044AH1

Price: $96.50

Coupon: 9.125%

Yield to Maturity: 10.496%

Maturity Date: 12/15/2021

Credit Rating (Moody's/S&P): NR/B-

Debt Type: Second Lien

Disclosure: I/we 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.

Additional disclosure: I own Ion Geophysical notes, due in 2021.