Callon Petroleum (CPE) is a small energy company based in Mississippi that engages in the acquisition, exploration, development and production of crude oil and natural gas properties in the US. However, we aren't here to discuss the fundamentals of the company as it relates to the common stock. In this article, we'll take a look at the company's Series A Preferred Stock (CPE-A, could differ depending on your broker) to see if it could be a good fit for your income portfolio.
CPE-A is a pretty straightforward issue; it is a traditional preferred stock in that it pays a stated coupon each quarter and has no maturity date. This means that CPE-A will be around as a long as CPE itself is still in existence and isn't called. In addition, dividends on CPE-A are eligible for the preferential dividend tax treatment which can really provide a holder in a taxable account a boost in after-tax yield in relation to a comparable interest-bearing security.
It is also important to note that dividends on CPE-A are cumulative. This means that even if CPE misses dividend payments it is obligated to make up the dividends to holders of CPE-A. Another kicker that gives CPE incentive not to miss dividend payments is that if six or more consecutive dividend payments are missed the coupon rate on the preferred increases by 200 basis points. This gives CPE tremendous incentive to keep paying the dividend and not miss payments but even if payments are missed, they are still owed to holders of CPE-A.
The face value of CPE-A is $50 and the coupon on the issue is $5 annually, paid out in $1.25 quarterly installments. This means the stated dividend rate on this preferred is a whopping 10%. The best part, however, is that CPE-A is currently trading for $47.05 as of this writing, giving the preferred a current yield of 10.6%. In a world of 3% 10 Year Treasuries, 10.6% is a very solid yield.
Beginning in 2018 CPE has the option to call CPE-A for the full $50 liquidation preference plus any accrued but unpaid dividends to holders. In the event you took a position today and the issue was called in 2018 you would be entitled to receive not only the $5 annual dividends but also a ~$3 capital gain on your position. This discount, although modest, does provide the opportunity for some upside in the event the issue is called in 2018 or beyond.
Despite all of these very nice characteristics CPE-A does have some risks. First, there is interest rate risk. A traditional preferred stock, like CPE-A, with no maturity date will trade up and down with the interest rate market, all else equal. This means that if interest rates spike in the future the price of this preferred will likely suffer, bringing the yield higher but inflicting capital losses on holders. This is the foremost risk of owning any preferred that has no maturity date and it is true with CPE-A.
In addition, CPE is a very small (~$250 million market cap) exploration company and as such, the prospect of financial ruin is real. CPE has been around since 1950, is breakeven on a cash flow basis and has shown the ability to raise funds in the capital markets when needed. However, a string of bad years could put financial strain on CPE and cause it to miss CPE-A dividend payments. You can judge for yourself if CPE is a risk to miss dividend payments and I encourage you to perform your own due diligence before initiation a position with CPE-A. At present, I don't think it is a risk but it is hard to say what will happen several years from now. If you get long CPE-A it is a imperative you monitor CPE's financial results on a quarterly basis in order to understand the company's risk of missing dividend payments.
If you can stomach the extra risk of owning a preferred on a very small energy exploration company CPE-A is a tremendous boost of income for your portfolio. The current yield of 10.6% is outstanding and the cumulative dividends and missed payment penalties make it very expensive for CPE to forego its obligations with CPE-A. In addition, the favorable tax treatment of the dividend payments from CPE-A make it attractive for even taxable account holders. Finally, there is the prospect of the issue being called in 2018, providing current holders with a modest capital gain of around $3 per share should the issue be called. Overall, if you've got the stomach for the extra risk of owning a very small company's preferred stock, CPE-A can be a terrific source of income for your portfolio. But if you get long CPE-A make sure you monitor CPE every quarter to ensure that if dividend payments could be missed you get out before that happens.
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. (More...)
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