No market segment is arguably more distressed today than the energy sector, but times of distress can create unique investment opportunities. I'm not talking about energy-related stocks, but energy-related bonds -- like those of Comstock Resources (CRK).
Bonds get very little attention from many investors because you rarely hear the media talk about debt, and bonds don't trade as easily as stocks do. But some energy bonds are providing equity-like returns these days with substantially less risk.
Consider the bonds of Comstock, an oil-and-gas company that trades on the New York Stock Exchange. CRK shares sold for north of $80 as recently as June 2008, but have tumbled with energy prices.
The company's market cap has shrunk to just $45 million or so, and the stock trades at around 90 cents a share today. Similarly, Comstock's April 2019 7.75% unsecured senior notes (CUSIP number 205768AH7) currently fetch just some 13 cents on the dollar.
Let's do some basic math on that. At 13% of face value, buying $1,000 of CRK's bonds will cost you just $130. The annual coupon of $77.50 is paid semi-annually, meaning you'll receive $38.75 every six months.
In other words, purchase CRK bonds at current prices and you'll recoup nearly 100% of your investment after just three coupon payments (i.e., over 18 months). Of course, that assumes that CRK doesn't default.
If it doesn't, each coupon payment after that will represent nearly a 30% return on your initial investment, or a 60% return per year. And the "jackpot scenario" would be for Comstock to pay back 100% of principal in April 2019. In that case, you'll collect more than $200 in interest, plus $1,000 in principal -- or $1,200 in total on a $130 three-year investment (an 823% cumulative return).
Very little actually has to go right for you to recognize such incredibly attractive profits. If Comstock continues to make its coupon payments, the bonds will appreciate very quickly and won't stay at 13 cents on the dollar for long. They'll also rebound if the market continues to feel confident about energy prices or oil rises just slightly from here.
What About Default Risks?
Of course, CRK's bonds are trading on the cheap for the obvious reason that the market believes the company might default on them. Let's take a look at that possibility.
Comstock recently completed a debt-exchange offer where it issued long-term bonds to pay off its first-lien line of credit. This means the company currently has a zero balance on its credit line. CRK also has some $134 million in cash.
However, the firm's current $1.3 billion of long-term debt costs Comstock about $120 million a year in interest. So, it appears at first blush that the company's $134 million of cash can barely cover one year of debt service.
But Comstock has been shrewdly buying back its bonds at discount prices. The company retired more than $120 million of debt last year at a cost of just some $40 million. CRK also recently redeemed $40 million in bonds for 4 million shares of stock that currently have a market value of just $3.6 million or so.
The Bottom Line
Comstock isn't the only energy firm whose bonds offer such potentially attractive returns.
These situations aren't easy to find or risk-free, but investing isn't supposed to be easy or risk-free. If things work out, your hard work and risk tolerance will definitely pay off!