When it floated on AIM in February 2017, Diversified Gas & Oil Plc (LON:DCOG) offered it’s investors a unique proposition among its UK-listed oil and gas exploration and production peers. It promised investors it would return 40% of its free cash flow by way of a dividend, thus offering them a high yield. It has already paid 1.99 cents per share and will do the same again in December, thereby demonstrating its ability to deliver on this commitment. In addition, in the seven months it has been listed, Diversified has shown that it can continue to grow by making further acquisitions in its principal area of operations (the Appalachian Basin in the northeast USA). Indeed, during that time, it has closed the largest deal in its history, delivering a substantial increase in production and, hence, cash flow for its shareholders.
A transformational transaction: In May 2017, Diversified Gas & Oil announced it had agreed to acquire approximately 7,300 wells from Titan Energy for US$84.2 million. Net production from this portfolio amounts to 41 mmcfe/d, which had the effect of boosting Group net output by more than 160% to over 66 mmcfe/d. We believe the successful execution of the transaction provided confirmation of Diversified’s competitive advantage in its core region. This is a function of a strong network of relationships, and a reputation as a credible operator, and its proven ability to access capital.
Financial strength will enable further growth: Net of expenses, Diversified Gas & Oil raised US$46.2 million when it floated in April and a further US$32.6 million in conjunction with the Titan Energy deal. In addition to this equity funding, the Group put in place a US$110 million debt facility of which just US$75 million will be drawn in respect of the Titan transaction. Hence, Diversified Gas & Oil has the financial capacity to make further acquisitions in the coming months and we would expect it to do so. In addition to the benefits these will bring in terms of production volumes and revenue, they also should enable the Company to maintain its track record of reducing costs as it benefits from economies of scale.
The shares have the potential to re-rate upwards: Using what we regard as prudent oil and gas price assumptions – US$50 per barrel for WTI crude and US$3 per mcf for Henry Hub gas – we estimate Diversified Gas & Oil has a net asset value (NAV) of 74p/share. However, this figure cannot capture the positive impact we expect from future acquisitions. Furthermore, after allowing for the Group’s hedging programme, we estimate even a modest 10% recovery in gas prices from their current depressed levels would increase NAV by 17%. The share price also looks well-supported by the dividend yield, which we forecast will be 5.9% in 2017 and 6.6% in 2018. We estimate Diversified would still offer investors the prospect of a yield over 5% in 2018 if its share price increased by 20% to 87p.
