DECPF - Diversified Energy's Track Record Is Worth Looking At

2023-04-11 18:55:01 ET

Summary

• The London-listed US natural gas producer has a strong production growth history and impressive dividend track record.
• Management appears committed to its growth strategy continuing.
• Innovative financing, large hedge book and production focus differentiate it from most other E&P names.

Diversified Energy Company PLC ( DECPF ) is a US onshore natural gas producer that follows a high-volume growth strategy. Its success has been nothing short of consistent, thanks to its ability to produce profitably at lower energy prices. This is attributed to the company's significant hedge book, which aims to keep profits rolling even in weaker natural gas markets, making it a model of consistency in a typically volatile sector.

Despite price action on the London Stock Exchange’s listed shares showing a fall of about a third from a 12-month high of £1.40 per share, Diversified Energy's shares are still better protected than most from the sharp decline in natural gas prices in recent months. Today’s price of just under £1.00/share, is a solid entry point for prospective investors as the shares trade in line with the sector average of six times forward earnings, and with an attractive dividend yield of 15%. The company's free cash flow and dividends are probably some of the most secure across London’s listed exploration and production companies. Diversified Energy isn’t in the exploration game either, taking out that element of risk.

Diversified Energy has made it through several cycles since its 2017 admission to London’s junior AIM market and it has kept its dividend distribution record intact. In 2019 the company graduated to London’s Main Market and the company is now a constituent of the FTSE 250 index.

The company's model of acquiring mature onshore US wells is unique. Over the past 20 years, the company has bought up almost 90,000 ageing wells, largely in the Appalachian basin, and added 17,000 barrels of oil equivalent per day (boepd), taking group output to almost 160,000 boepd. Its fully owned pipeline network of some 17,000 miles is also an underappreciated asset, as it saves on paying transit fees to third parties.

However, the company is not short of critics. Last year, an environmental group called into question Diversified Energy's ability to plug all its uneconomic wells, given the scale of its operations. The Ohio River Valley Institute estimated Diversified Energy would plug just 4% of its inventory between 2019 and 2034, or 2,600 wells, and that 80% would not be decommissioned until after 2049. Diversified Energy closed just 214 wells last year, at an average cost of $23,000 each, and although the purchase of a well-plugging company should boost its annual closure capacity to 350, the group is reliant on slowly squeezing every possible molecule from its fields.

Diversified Energy's success is based on its ability to balance out the rewards when prices are high for protected profits in the leaner times. Its hedging strategy is perhaps the hallmark of its financial model. In 2022 and 2021 it recorded losses on its commodity derivative positions (offset by high gas prices), but in 2020 its commodity derivative positions recorded profits offsetting the low natural gas prices the company would have received in the spot market.

Although the company is highly acquisitive, and makes use of innovative asset backed securitization to secure attractive financing, the company aims to keep net debt to adjusted EBITDA to less than 2.5x, which at the end of 2022 was its level. Management’s bonuses are tied to this metric, so we know the incentive is to keep debt levels manageable.

Diversified Energy plans to list shares in the US and identify ways to develop greenfield assets, all without breaking its high-return, high-volume strategy. These plans won’t change two constants for the company: it will continue to buy onshore US mature wells with a mix of debt and equity and keep hedging production. Although the company will likely continue facing scrutiny over its well management practices, its 2022 Sustainability Report published on 11 April 2023 was comprehensive, developed in reference to all the main sustainability reporting standards and frameworks: Global Reporting Initiative Core Standards, the Sustainability Accounting Standards Board, the United Nations' Sustainable Development Goals and the Task Force for Climate Related Financial Disclosures. Importantly the company reduced methane intensity by 25% since 2020.

In conclusion, Diversified Energy Company PLC has developed a strong track record of rolling up mature natural gas fields into its stable and producing production growth. Its ability to produce profitably at lower prices thanks to its significant hedge book, and unique model of acquiring mature onshore US wells make it an attractive prospect for investors looking to gain exposure to the commodity traders call “Nattie”. While the company is not immune to criticism, particularly regarding its ability to plug uneconomic wells, natural gas is a key component to the US government’s drive to electrify American industry and transport. Given the company is far more “gassy” than nearly all other London oil and gas E&Ps, which are by and large predominately “oily”, when oil prices come back down, fund managers will no doubt want to decarbonize their energy sector exposure by switching into the limited group of gas focused names, of which Diversified is most prominent.

Diversified's hedging strategy is not for every investor, and its success is dependent on balancing out the rewards when prices are high for protected profits in the leaner times.

The stock is firmly on my watchlist and I’m strongly considering a purchase.

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