A high-yield energy stock with locked-in prices

Even with the hedges, the company still announced record sales and earnings when it published 2022 figures last week. This year, the hedge book will remain in force. So while Diversified’s shares have tracked the sector in falling a third from a 12-month high of 140p, it is better protected than most from the sharp decline in gas prices in recent months.

As such, this is a solid entry point for prospective investors. For context, the shares trade in line with the sector average of six times forward earnings, but with a dividend yield of 15 per cent. This kind of payout ratio is not unknown for an energy company, but what differs is its apparent security. Peel Hunt analysts called the company’s free cash flow and dividends “some of the most secure in the sector” last week, after adjusted Ebitda for 2022 jumped 47 per cent to $503mn (£409mn).

The majors also offer a compelling dividend story, but are much more exposed to oil and gas prices. Mid-tier companies – some still carrying significant debt and shrinking reserves – face a different set of circumstances but also need higher prices to carry on handing out dividends at current levels.

Since its 2017 Aim listing, Diversified has made it through several cycles with its distribution record intact, and its model of acquiring mature onshore US wells largely validated (if heavily dissected).

This model remains unique. Over 20 years, the company has bought up almost 90,000 ageing wells, largely in the Appalachian basin. The latest deal, worth $244mn and funded partly through a $163mn raise, added 17,000 barrels of oil equivalent per day (boepd), and takes group output to almost 160,000boepd, and the fully owned pipeline network to some 17,000 miles.

E&P without the E

The company is not short of critics, however. Last year, a report from an environmental group called into question Diversified’s ability to plug all its uneconomic wells, given the scale of operations.

The Ohio River Valley Institute estimated Diversified would plug just 4 per cent of its inventory between 2019 and 2034, or 2,600 wells, and that 80 per cent would not be decommissioned until after 2049. Diversified 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 appears reliant on very slowly squeezing every drop from its assets.

The concern of the report’s authors is that without a long-term plan, the billions in clean-up costs will ultimately fall to the states where Diversified operates. The company said it was a “responsible steward” and “a critical part of the solution to producing more US natural gas with less methane emissions and environmental impact”. It also emphasised that 2022’s closures were ahead of regulatory requirements.

At the same time, Diversified has continued buying up assets, and has spent over $1bn since the start of 2021. Chief executive Rusty Hutson’s 2020 comments to Investors’ Chronicle that crashing gas prices would provide significant buying opportunities has proved prescient.

There has been a shift in tone, however. In its latest annual results, the focus switched to how many wells it could retire, rather than how many the company had amassed. Diversified was also keen to point out that inspections were done at more than 10,000 wells in the year, noting that most of its wells’ methane emissions are “a function of fugitive emissions and natural gas-driven pneumatics”, which can be addressed with “aggressive leak detection and repair initiatives” and wellhead refits.