UK Markets close in 2 hrs 7 mins

Does the 13%+ Diversified Energy dividend yield mean I should buy?

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Image source: Getty Images

With a dividend approaching 14% (yes, 14%!), Diversified Energy (LSE: DEC) continues to intrigue me. Often a high yield is an alarm bell that the dividend might be cut. On the other hand, the gas producer has a track record of annual dividend raises in recent years. As a long-term investor, is the Diversified Energy dividend outlook attractive enough for me to invest?

Recently rising

Last year, Diversified again lifted its payout, by 2.9%. if it continues at that level for the remainder of the company’s financial year, this will be the fourth year in a row of dividend growth at the company.

However, past performance is not necessarily a guide to what comes next. Indeed, over the long term I have some concerns about whether Diversified can even support a payout at the current level, let alone fund bigger dividends.

Loss-making company

In its most recent annual accounts, the company reported a full-year loss of $325m after tax. It made a loss at the operating level ($467m, equivalent to 46% of revenue). But its pre-tax loss was even bigger, at over half a billion dollars. In other words, the numbers looked less bad after tax than before it. That is always a red flag to me. In my view a healthy business ought to be seeing the tax line worsen, not improve its final earnings.

The prior year saw the same pattern albeit on a smaller scale: a loss at the operating, pre-tax profit, and post-tax profit levels.

At the interim stage this year, the firm remained loss-making both at the operating and net income levels.

Positive operating cash flow

Companies pay dividends using cash, however. Profits and losses are an accounting concept and can be quite different to the cash flows at a company.

Diversified aims to pay dividends of about 40% of its free cash flows. At the operating level last year, operating free cash flows were $320m. The dividend cost of $130m was indeed roughly 40% of this.

But that is operating free cash flow, which is different to total free cash flow. The company saw $626m of net cash outflows on investing activities. Cash flows were boosted by $317m of net cash from financing activities, but that included $1.7bn of proceeds from borrowings.

My move

Diversified has a novel and potentially lucrative model. It has bought up tens of thousands of small aging gas wells. Purchasing that many wells costs money, as seen in the company’s investing cash outflows.

Raising money has helped the company expand fast — hence the borrowing. This month the company also raised around £135m net of new cash by issuing shares. That could help fund expansion, but at the cost of diluting shareholders. Further dilution is an ongoing risk.

Revenues and profits could rise — or fall — as energy prices move. The capping costs of an estate of old wells could be high. On top of that, Diversified is cash flow positive at the operating level, but has substantial non-operating expenses such as acquisition costs. Interest costs alone last year were $42m.

Juggling those cash flows looks like a delicate balancing act to me, especially if energy prices crash. The Diversified Energy dividend could keep rising. But I see a risk of a future cut. I will not be investing.

The post Does the 13%+ Diversified Energy dividend yield mean I should buy? appeared first on The Motley Fool UK.

More reading

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2023