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Review of current status
https://seekingalpha.com/article/4694971-diversified-energy-company-cheap-assets-solid-dividend
Behind Paywall but managed to get to it
Part 1
Diversified Energy Company: Cheap
Summary
Diversified Energy Company stock has been undervalued due to pessimism, despite consistent cash flow and strong adjusted EBITDA.
The company owns wells in the Appalachian Basin and focuses on acquiring existing long-life producing wells.
Q1 earnings showed solid cash flow, buybacks at attractive prices, and decreasing debt, suggesting the stock is mispriced.
Shares are a buy with a price target of at least $20.
SimonSkafar
Investment Thesis
Diversified Energy Company (OTCQX:DEC) has been an underperformer for the past year, down significantly and approaching a rock bottom valuation. Given the consistent cash flow from operations the company has, I find this pessimism to be unwarranted and think the stock is undervalued. Free cash flow and adjusted EBITDA continue to perform quite well in my view, leading me to believe the market does not appreciate the fundamental improvement of the company. With a prudent hedging program and solid operational results, I think the stock is a buy.
Company Overview
Diversified Energy Company is "an independent energy company engaged in the production, marketing, transportation and retirement of primarily natural gas and natural gas liquids related to its U.S. onshore upstream and midstream assets" according to its website. Basically, they own a bunch of wells and other oil and natural gas producing assets that generate steady cash flows for investors.
They focus on "acquiring existing long-life, low decline producing wells" and "do not actively engage in large-scale, capital-intensive drilling and development programs that seek to capture short-term high production and revenue". Therefore, the cash flows are relatively stable as those wells sit there and produce natural gas at prices that are hedged with contracts purchased by management.
The company owns wells and operates in the Appalachian Basin, with 141 mboepd average daily production and 842 MMboe proved reserves, according to its website. Long term, I think this is attractive as the country still uses fossil fuels to power electricity, so my belief is that production rates should increase as the company continues to strategically acquire more wells.
Website
It is rather interesting to see a company with $2.6 billion in acquisitions trade at a market cap of below $1 billion. I got interested after seeing this discrepancy and wanted to see if the stock was undervalued, or if these acquisitions were truly disastrous and thus deserved a markdown. To my surprise, since the IPO, cash flows have increased from $87 million in 2018 to $410 million for TTM. The stock is now reaching all-time lows, which leads me to believe there's some mispricing here.
Part 2
Q1 Earnings Review
The company reported Q1 2024 earnings on May 9, 2024. Here is the brief summary,
Production essentially flat from 4Q23 adj. production of 725 MMcfepd (121 Mboepd)(A)
Operating Cash Flow of $107 million, and Net loss of $15 million inclusive of non-cash unsettled derivative fair value adjustments, and non-cash depreciation, depletion and amortization
Achieved 1Q24 Adjusted EBITDA of $102 million and Free Cash Flow of $74 million
So, investors can see the company is earning solid cash flow, with adjusted EBITDA that roughly matches operating cash flow. Production is relatively flat, but certainly not low enough to justify a stock price decline of over 40% in the past year, in my view. Overall, the quarter showed continued consistency in the cash flow, which is enough to support the dividend of $0.29 a quarter.
The company is also starting to buy back shares at attractive prices in my view. For the quarter, the press release says, "Repurchased ~400,000 shares in 2024 for £3.9 million ($5 million) at an average of £9.74/share", which translates to about $12.38. Management seems to know that their stock is undervalued and is putting money where their mouth is with their buybacks.
Debt is heading the right way, down "~20% (~$309 million) compared to Q1 2023". With these fundamentals heading the right direction, I am surprised that the stock trades so low. With strong cash flows, repurchases and dividends, production holding tight, I question whether the market is pricing this one correctly.
CEO Rusty Huston commented in the press release, "I am pleased that our ongoing focus on cost reduction opportunities has translated directly into a 7% sequential quarterly operating cost improvement, allowing us to effectively navigate the current natural gas market headwinds". Given natural gas trades at around 5 year lows, I am surprised to see the business hold up pretty well. Their cost reduction and hedges seem to be working, with free cash flow of $74 million a quarter could translate into $200+ million of free cash flow for 2024. Management seems to be keen on continuing buybacks, so I feel confident that this quarter demonstrates the fundamental story behind Diversified Energy is still intact.
Hedges Outweigh Low Natural Gas Prices
A key reason why I think this stock is misunderstood is because people may think it sells natural gas and therefore will struggle given low natural gas prices. Henry Hub shows a significant decline in price, from as high as $9 in 2022 to below $3 today.
Google Finance
However, after reviewing their financials and investor presentation, I am surprised to see that management has intelligently hedged for this risk and still churns out steady cash. According to their presentation, 85% of their production of natural gas is hedged at prices that are favorable for shareholders. The hedged benchmark price is enough for the company to still be operationally profitable and gush free
Part3
Investor Presentation, Page 6
Clearly, low natural gas prices don't mean much to shareholders, as the hedges are doing their magic in keeping cash flow intact. Thus, this may explain why the stock is mispriced in my view, as people do not see that the hedges are outweighing low natural gas prices. In fact, it is precisely in this natural gas market where a company like Diversified Energy should shine. While their peers may be suffering lower profits and cash flow, a hedged strategy should allow Diversified to take the higher cash and reinvest in exciting projects and new wells to take advantage of a potential future upturn in natural gas prices. This strategy speaks well to me because I like the downside protection it gives, and think gives investors stable cash flows in any natural gas market environment.
The quarterly dividend of $0.29 seems sustainable to me, as the cash flows seem to be resilient to natural gas price fluctuations. I think investors are being paid to wait while seeing the company cut costs, focus on increasing production, and hedge cash flows intelligently. Management's strategy on acquiring "long-life, low decline producing wells" is unique and effective because it allows for a level of certainty in long-term cash flow and looks easier to manage operationally in my perspective. In conclusion, I think the cash flows will continue to be stable, can cover the dividend, and give investors solid income while they wait.
Part 4
Valuation - $20+ Fair Value
I will base my valuation on the cash flows of the company because I think they are predictably stable and also resilient to natural gas price fluctuations. For 2024, I expect the company to be able to earn at least $200 million in free cash flow, by taking $50 million of free cash flow in the first quarter and multiplying it by 4 to annualize it out. Given the free cash flow came in at $74 million for Q1, I think $200 million in FCF for 2024 is reasonable as $74 million actual for Q1 2024 is much higher than my projected $50 million of FCF a quarter. Also, FCF for 2023 was $219 million according to their presentation, so assuming it can hold at around $200 million seems reasonable as the hedges do their work in keeping cash flows stable.
Divide $200 million in FCF by shares outstanding of ~50 million gets me around $4 FCF per share. Multiply FCF by a below-average P/FCF of 5 gets me $20 per share fair value, with what looks to me incredibly conservative assumptions. Ultimately, the free cash flow is all that matters to me and I see it staying at the very minimum flat for the next year or two due to smart hedging and mature wells that don't deteriorate that quickly.
I also find it unusual for a company that has historical acquisitions exceeding $2 billion to somehow have a market cap of below $700 million today. Those acquisitions seem to be value-add, as they increased the production capacity and cash flows of the company since they occurred. If I bought $2 billion of wells, oil producing assets and infrastructure, hedging contracts, and suddenly, it's selling on the market for $700 million today, I'd think the market is severely undervaluing my assets. That's exactly what, I think, is happening to Diversified Energy at this price, and thus believe the stock is probably undervalued.
Part 5
Risks
Given the historical acquisition spree the company has gone on, one has to be concerned if management takes a turn for the worse and makes poor decisions about future acquisitions. Goodwill impairments, asset write-downs, and other indicators of bad purchases could dent shareholders' equity and put the stock lower. Investors need to put some faith in management, as they seem eager and keen on making acquisitions to grow.
Environmental regulations could restrict the output of natural gas, as the country becomes more reliant on renewable energy instead of fossil fuels. In the long term, the company could face a secular headwind as the country shifts to solar and wind energy, and demand for fossil fuels wanes. Future regulations may restrict profitability and make it hard for management to expand operations.
Hedging may not always work, as past performance is no guarantee of future performance. If natural gas prices get super low, even the hedging can only do so much to protect cash flows. At a certain point, gravity takes over and extremely low natural gas prices may make it difficult to sustain cash flows despite smart hedging practices.
The company also has some leverage, coming in at over $1 billion. While not too worrisome, a slowdown in cash flows could lead to increased financial pressure on the balance sheet as management has to keep debt levels under control.
Buy Diversified Energy
Rarely have I seen a company with such good cash flows trading at such a low price. I'm rather impressed by the hedging, mature wells, and overall free cash flow the company generates. Management seems to be pretty smart about acquiring assets that fit the business model, so with over $2 billion in historical acquisitions, I think the market is severely underpricing the company today. Investors should look to Diversified Energy for its solid income and cheap assets at a bargain price.
Oh dear Terry, GG won't like that article one bit when he wakes up in lala land in a couple of hours!! LoL
Of more immediate significance (and I hope I don't speak too soon) the SP seems to have weathered the ex-divi of 29 cents (circa 23 pence) and is currently holding it's own on what some feared could be a particularly grim day.
Is this a turning point for DEC - might be?
Let’s see if Seeking Alpha readers in the US put their buying boots on this afternoon - they should be happy to buy up to $20!
I’m pleasantly surprised to see a generally FTSE down day and xd haven’t hurt the SP.
Hopefully a turning point as Notrex says - but then we’ve had a few potential turning points let us down.
I played this through a few valuations calculation and most show upside some models do not of course but all in all I see this a cheap from pure valuation perspective all they way up to £14 per share although analyst see £23
I think this long hold, historically we had 602 up days 611 down days (few big one s of course and ex div days) finally 47 flat days.
I am fortunate to bought in low so am currently up 18%
NY 1.3% up, London up 0.5%, looks like we go the dividend as a bonus at least for now. Also HH now at 2.9.
Thanks Trek for suggesting Brave, so much quicker and without all those annoying adverts.
Well today is quite a suprise. I expected a bashing.
Not rocket science, if keeping to DEC presentation released earlier in May. 47% reduction of debt ($1bn as of now) by 2026 to roughly $500m. With hedged reducing year on year (currently @85% for this year), while keeping a debt leverage avg of 2.1x and hopefully increasing their ARO retirement obligations. Should keep the wolves and loony tunes at bay.. i will be asking father Christmas for a special dividend at some point fingers crossed. Imho
Dazzle
PS:
Henry Hub leveraged at way over $2 for the next two years, so all the bashing by the usual suspects to cry wolf ( for hidden agendas) just shows the disingenuous moronic ineptitude and lack of factual research to base any counter claim or debate. For those of you who dislike facts and are easily triggered then investing isn't for you. IMHO
Dazzle
Terry,
Brave - you are welcome. I have been using it for years now, no issues.
Thanks for posting the Alpha link.
Trek,
£15! Lol!
'....To my surprise, since the IPO, cash flows have increased from $87 million in 2018 to $410 million for TTM. ...'
'Surprise' is an understatement, lol. Where did it go, all that cash, do you suppose ?
I forgot how literally you morons read things. When I ask the question of 'you' I refer to this board, not the article writer.
Told 'you' GG wouldn't like it one bit!! LoL
‘ I forgot how literally you morons read things.’
Like your posts?
£15! lol!
Trek
Couldn’t resist!
Never get it when ppl post random negative comments without backing it up with facts, for years value investors have made money on mispriced stocks..is this one of those time will tell, those that invested here believe it is, or some are simply holding to recover there losses which I get.
If nothing value save time and breath
Trek, thought you were filtering greygeorge ? I admit that I feel I'm missing something while still doing it, bit like seeing only parts of a soap opera !! However, the benefit is not seeing his nasty comments !!
Hi Clued,
No I don’t have him filtered. Would miss the laughs!
The more he deramps the higher the stock goes and I am one of the lucky ones here now up significantly esp with divi’s!
The only posters I have on filtered are a load of rampers from the AVCT BB and that’s going back to the covid rise there. They were still going on when I started selling down from over 200p after a crazy run!
Anyways great data on seeking Alpha. I agree it’s the pay down of the ABS notes that will really turbo the SP here with the low declines.
I am overweight so can’t really add more although would if it pulled back. I am getting +10% on one account and +9% in the other after withholding taxes and the Bod have virtually guaranteed that yield for two years.
Goodness knows what the SP and divi will be when the debt runs off and rates turn!
Expecting more than £15 but £15 is my near term expectation here.
Usual caveats
Trek
£15! lol!
Well done Trek, you're doing better than me on this share. I have enough here and generally won't average down in such a case, so being patient. I'm doing very well with BA., RR. and BAB especially, but have taken profits on some others like BP and bought back though at a higher than the current price. Plenty of good prospects for others though slower than expected, eg IAG !!