I was writing a response to the excellent questions raised by reader "James" in response to my September 16 column on Miller Energy Resources when I realized the response was actually column-length.
Instead of making James read a much-longer-than-prescribed answer to his question, I decided to flush this out into a full column. James asked about my fair value estimates on Miller Energy (MILL) and why I was buying Miller's Series D preferreds instead of the series C. Here is my reply:
I am in print with a fair value of $11 per share for Miller. I am meeting with management next week at their Alaska assets, and I will publish a detailed piece, including updated valuation afterward. The Series C converts at $10 per share at the holder's option and can be forced by management to convert at $15. With the common trading at $4.62 the value of that implicit call option is quite low, unfortunately.
I bought a fair amount of the C in late-2012 and 2013 for my clients and am holding onto it now as a good credit investment. MILL-C has appreciated 8.3% this year (so a total return--assuming no reinvestment of dividends -- of 16.4%,) and I believe MILL's increasing cash flow makes it an attractive credit. It's trading at a 4% premium to face now after years in the discount-to-face penalty box, so clearly the credit market agrees with me.
Again, the optionality on a security that is more than 100% out-of-the money and has a first call date of Nov.1, 2017 is quite low. So the C has done well as a bond, even is its value as a convert dwindles every day.
The D is not convertible, but does offer a floating rate feature (LIBOR + 9.073% on Sept. 30, 2018). And it offers a coupon rate that is not materially different (10.5% versus 10.75%) than that of the C. MILL-D has performed spectacularly this year, posting a 12.8% price appreciation. That translates to a sizzling pre-reinvestment year-to-date return of 20.7%. It's been great, but I am still buying more. Why?
My clients ask me on a daily basis how I will fortify their income-based accounts against higher interest rates. Floating rate or fixed-to-float securities (like MILL-D) are a hedge against inflation. I am not as bearish on Treasury rates as some (and making that call has been extremely lucrative for my clients this year). But I realize some day, some way interest rates will approach their historic norms.
We'll protect ourselves with the floating feature on the D, which the C does not have. Also, the D's first call date (the same as its float date) is Sept. 30, 2018, versus the C's first call date of Nov.11, 2017. Bond math ("yield-to-worst") dictates that later is always better in terms of call dates, and so that element of call protection favors the D.
I am frustrated with the 2014 performance of MILL common -- the laggard of my 10 mad money names -- and so is management, I can assure you. But I am about to spend a couple days with them in the Cook Inlet. In addition to obtaining cool pictures of me standing on an drilling platform -- I intend to walk away with MUCH more detailed information which will allow me to fine-tune my valuation model. More to come on that next week.