The Diversified Energy (LSE: DEC) share price has fallen by 20% since early October and is down by around 12% so far this year. This weakness has left the US gas producer trading at under 100p and offering a 12% dividend yield.
A yield this high is unusual. In my experience it’s often a sign of problems to come. But Diversified’s payout has risen steadily since its flotation in 2017 and the company’s latest trading update didn’t seem to reveal any new problems. Is DEC an overlooked bargain I should buy for my portfolio?
What’s the story?
Diversified Energy is a slightly unusual business. The company operates around 69,000 gas producing wells in the USA, in states including Virginia, Pennsylvania and Ohio.
These wells are generally older wells that are past peak production. Diversified buys the wells from other operators and then runs them for cash until they reach the end of their useful life.
Gas production rates from Diversified’s wells are pretty low. However, Diversified’s pitch is that as a large operator, it can run these wells efficiently and have the resources needed to decommission them responsibly at the end of their useful life.
So far, this model seems to have worked well, at least for shareholders. The stock has risen by 75% since January 2017 and the dividend has risen steadily, supported by cash flow.
Why DEC stock plunged
DEC’s share price fall in October was triggered by a critical press report. This suggested that many of the company’s wells are leaking natural gas, which is mostly methane. That’s a potential concern, because methane is believed to have a much greater impact on climate change than carbon dioxide.
Diversified has denied these allegations. But in the weeks since then the company has announced plans to step up its monitoring activity and spend an extra $15m per year on reducing emissions from its wells. The company also plans to increase the number of wells it decommissions each year to 200 by 2023.
For me, decommissioning is the big worry here. A single well costs around $22,000 to shut down, based on the company’s latest update. At that rate, decommissioning all the company’s wells could cost close to $1.5bn.
Most of this spending is a long way in the future, according to CEO Rusty Hutson. But I’m concerned that the company doesn’t seem to be making any plans for this. Instead, most surplus cash is paid out as dividends each year. Debt levels are quite high, too, in my view.
DEC shares: should I buy?
For now, I think Diversified Energy’s 12% dividend yield is probably safe. The company should be benefiting from strong gas prices and also has hedging in place to protect against falls.
However, I can see multiple risks to this payout in the future, perhaps quite soon. If I’m right, then the DEC share price could have further to fall.
Although I’m tempted by the stock’s 12% yield, the situation is too speculative for me. That’s why I won’t be buying Diversified Energy shares.
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Roland Head 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.
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