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Next, consider the acquisition itself.

The announcement and presentation state that we are acquiring assets which produce 17 Mboepd in a 76/5/19 split between gas, oil, and NGLs. Adding this acquisition in to the projected figures for 2023 - noting the decline rate (for all assets) of 10% and that the effective transfer date will be 1 Feb 2023) - suggests that DEC will have production of 146.3 Mboepd in FY23. Of course, this assumes no disruption to production, but it also assumes no further acquisitions.

In FY2023, this would translate to post-hedging revenue of $1.3bn. (Assumptions are $3.46 gas, $70 oil, $36 NGLs.)

Assuming costs at $10.97 per Boe, this implies total cash expenses of $585m - and therefore cash profit from the core business of $714m - a cash margin of 54%. Or, in other words, cash profit of $0.73 per (post placing) share in issue - which would be a 50%+ improvement from the $0.47 profit per share that I've calculated above for FY22!

I am absolutely astounded that the share price has managed to dip under £1.
To me, this fundamentally undervalues DEC and its highly cash generative business.

Consider the following:

The January trading statement confirmed that DEC's production over FY22 was 135 MBoepd. My calculations are that this translates to revenue from hydrocarbon sales of $975m. (This calculation assumes the following effective prices after hedging: $3.02 gas, $76 oil, $16.61 NGL.) DEC also have some mid-stream revenue - $31m in 2021, so I feel justified in predicting total FY22 revenue of over $1bn (i.e. about £830m).

We are told that the cost of production is $10.41 per Boe, so total cash expenses can be accurately calculated as being around $512m.

This means that DEC's core business made at least $462m in FY22 - probably more as this equates to a cash margin of 47.5% which is lower than DEC's claim of 50%.

On the basis that, post placing, there will be around 970m shares in issue, that is cash profit of $0.47 per share for FY22. To my mind, this rather suggests that the dividend of $0.175 is safe as houses.

Even after capex, plugging costs, interest expenses etc. - I would expect to see in the annual report that the dividend (even with the additional placing shares) is covered twice over by cash profits from the core business.

Suggestions that DEC would need to cut the dividend as a result of the placing are, I think, fanciful.

Indeed! Maybe if gas prices go down a bit more then DEC will have a huge mark-to-market profit to report!?
No doubt the market will promptly discount such profits as "propped up by the hedging".

In seriousness, I think DEC does miss out on investors who have strict investment criteria which cannot look past a headline 'loss' in the annual report, or who place a lot of faith in metrics such as P/E ratio which are spoofed by a 'loss'. So may not be at all a bad thing for gas prices to soften a bit so that DEC can report a profit.

Anyway, 11% yield (after 15% tax) is too good to miss, so I have topped up with another £2500.
Post-top-up, I'll now be getting over £1k per quarter in dividends from DEC (at current FX rates).
This is now my second-largest holding in terms of value, going past L&G, behind only Aviva.

I find this a curious complaint to be honest. I feel you'd have to be either a very recent or very unlucky investor in DEC to be underwater at this SP.

I first invested in DEC in April 2021 at a price of £1.24, but my average price is now £1.08. No trading genius here, either - to be candid, the timing of some of my buys could have been a LOT better than it actually has been! Moreover, after the December dividend is paid on 28 Dec, I will have received a total of £1 back in DEC dividends for every £7 I originally invested.

Personally I am reasonably pleased with progress here.

Where else can you get a solid 10% yield after tax, plus a rising share price? Indeed, which of us would have even heard of this stock if it had not been for the attraction of the safe dividend yield?

Krusty - I think it is a bit simpler than that.
The quarterly divi will go up from 4.25c to 4.375c: an increase of 0.125c.
Multiply by 4 quarters - equals 0.5c per year - exactly $50 extra annually per 10k shares.
At current FX rates, that is around £42.50 - about £36 if you are an ISA holder paying 15% WHT.

Trek's £22 may have been referring to the uplift for the 2022 dividend year (i.e. applying the uplift to only Q3 and Q4).

Like others, I am encouraged by the results, but a little disappointed by the dividend. I had expected an increase to 4.5c.

However, with higher production in Q4 now that Conaco Philips is on-line, DEC is well placed to finish 2022 strongly. And, notwithstanding the increased costs of production - DEC should make a LOT of money in 2023 selling gas for $3.53 post hedging - and those profits will be split among fewer shares in issue following the buyback (which is only about 10% complete by my reckoning).

So maybe DEC will inch up the dividend again in time for Q1'23 dividend.

Hi Trek

GLG also declared a major holding on 6 October, going from under 5% to 5.0006%. I suspect that this was caused by the buyback - i.e. GLG were sitting on slightly less than 5% and then, as the buyback reduced the total shares in issue, they went over 5%.

By the way, 5% is the lowest threshold for market notification under DTR 5.1.2 because DEC is a non-UK issuer (as per the GLG filing).

It's conceivable that GLG may have a rule (or an informal policy) that the fund will not hold a disclosable stake in any one company - so going above 5% might mean they are required to sell a few.

My thought is that GLG have just sold enough shares/financial instruments to ensure that they dip back below the 5% threshold - and possibly enough to ensure that they stay there regardless of the pace of the buyback (i.e. down to around 4.5% of the pre-buyback share capital.)

MJ

ThroneGames - it depends what you mean by earnings!

The earnings per share for 2021 is on p49 of the annual report - but due to the mark to market loss on hedging, the EPS was a loss of 41c per share, so the PE ratio would involve dividing by a negative number...not much use!

If you are willing to take the FY21 adjusted EPS per share (19c/share) then, at today's closing price of 125.8p (144c), you'd have 144/19 = PE ratio of 7.5.

I am not sure that PE ratio is much use in analysing this company, because headline earnings per share will fluctuate up and down quite a lot due to the mark-to-market accounting on the hedging.

sotonspike - that is the Q2 dividend, which, as you say, was announced in August and will be paid in December.

We are talking about the Q3 dividend, which is normally announced about now, and paid in March.
And hoping it will be north of 4.25c!

Just had a look at the HY interim statement and it looks like we are at 3% oil, 10% NGLs in terms of production volume.
Extrapolating from the current production volumes and applying the full year hedge prices, my spreadsheet suggests that in FY22, oil will end up being around 12% of post hedge revenue, and NGLs 9%.

All I meant by flat is that the divi has stayed at 4.25c for 4 consecutive quarters: Q3'21, Q4'21, Q1'22 and Q2'22.
Which was not intended as a criticism, but merely an observation.

DEC have a habit of announcing dividend increases at the Q3 announcement - they did in 2021 and 2020.
My prediction is that next week we will get a (rather conservative) uplift to 4.50c.

Although, given that there will be 8-10% fewer shares knocking around by March next year...and the reduction in shares won't affect the free cash flow...maybe we might get a bit more? A 20c annual dividend would be a nice little Xmas present from Uncle Rusty? Make a name for DEC too as an inflation buster.

It seems to me that the Q3 dividend announcement is due any day.
Generally announced at the end of October - so to be honest I was expecting something on Friday.

This is particularly of interest as the 17c dividend has now been flat for a year - so far, DEC have been extremely enthusiastic about regularly raising the dividend so I hope this won't change.

My slight concern is that the share buyback could be used as an excuse not to raise the dividend - I hope this is not the case.

Any thoughts?

Hi pb1943,

It is mostly gas, with only a little oil and some NGLs.
In FY21 I believe it was around 8% NGLs and 1.5% oil in terms of production in Mboe (using 6 MMcf = Mboe).
Obviously oil is more valuable, so in terms of post-hedge revenue I think it was 9% NGLs and 5% oil in FY21.

I think it will be a little higher in FY22 due to the Tapstone acquisition, but I haven't reconciled this to company results since February. However, you are still looking at production of being - at most - circa 9% NGLs and 2.5% oil, with 80%+ of revenue from gas.

My approach in the past has been to invest on the basis that DEC is a pure gas producer - the NGLs and oil then constitute the 'cherry on the top' and provide a margin of safety. But you are right to look at this as the increased NGL/oil mix is a nice bonus of Tapstone acqn and is perhaps under-appreciated by many investors.

Find it incredible that this share can drop like this in the context of the pound going through the floor against the dollar.

The super-safe dividend of 17c is now equivalent to 15.55p - or 13.21p for ISA holders (after 15% tax).
At 123p that is now 12.6% yield for SIPP-sters, 10.7% for ISA holders.

That's got to be attractive - even before we consider the strong possibility of a rise in the dividend soon.

Agricore - I previously considered this exact issue in February this year. As you have sold out (presumably with good profits, well done!), this may no longer be relevant to you, but thought it might be helpful to others reading your post.

My understanding is based on p13 of the October 2021 Investor Presentation, and it is as follows:

1) Let us assume that DEC has a projected production volume of 50,000 MMcf for Q3 2023 and, at FY2021 year end, have hedged 50% of it at an average price of $3.00/Mcf. (That level of hedging for a period 21 months away would be broadly in line with the hedging strategy set out on p98 of the Capital Markets Day deck.)

2) Let’s further imagine that the Henry Hub gas price at 2021 year end was $4.00. The Company’s hedges at $3.00 for that Q3 2023 would be underwater – they would owe $1/Mcf on the hedged volume. In other words, the Company would (hypothetically) owe the counterparty $25m if those Q3 2023 hedges were (for some reason) suddenly unwound.

3) Of course, $25m in the red is pretty small beer, but $25m in the red for 10-12 future quarters can stack up pretty quickly. It is this ‘paper loss’ of multiple future quarters that is reflected in the accounts – see the 2021 HY accounts for a good example of this.

4) However, when we actually get around to Q3 2023, the Company will have that 50,000 MMcf of gas, and if it is able to sell it at $4.00 then it will have $200m of revenue from gas sales in the quarter. At that stage, DEC would have an actual cash loss of $25m on the hedging, but have made $50m more on gas sales (than if the price was $3.00).

Plainly, higher gas prices are a Good Thing for DEC because DEC produces and sells gas and never hedges 100% of its production. However, the 'mark to market' accounting rules produce some strange results due to the obligation to recognise paper losses from underwater hedge contracts, while not reflecting the cash gains that DEC would make if the gas price stays at the high level.

So, the answers to your questions are:

1) If gas prices never go down, then DEC simply sell the gas they have produced at very high prices, which is a Good Thing. The non-cash hedging loss (for each relevant quarter) will at that point become a cash loss - but that cash loss will be offset by very high revenue from sales of gas.

2) The hedging loss can be greater than operational profit because the hedging stretches a few years into the future (albeit not in respect of 100% of production), while the operational profit is a figure that refers to only six months' worth of DEC's activity (or 12 months for annual numbers). If you look back in the accounts to when the gas price fell significantly, then you will no doubt see hedging gains which exceeded the operational profit for the period being reported on.

Carcosa61 - that confused me as well!

I need to compare the Cenkos note from May with this one to find out what assumptions have changed.
Possibly costs in a high-inflation environment?

But, with an average cost for my holding around 105p, I would happily settle for a re-rating to the 160s!

Cenkos have just published their latest coverage following the interim results and the acquisition.
They suggest a price target of 166p...still plenty of upside in this one as well as being a dividend machine.

I was under the impression that the "139 Mboepd in December" figure was an aggregate figure which included all production: gas, NGL and oil - and that they report it in Mboepd because it is a production figure which combines categories. It is a little opaque though. I might email the company and see if I can find out.

In any case, I'm very happy with the update, and (for once!) the market seems to agree.

Ragnar - do you mean for FY21?
If so, that sounds about right.

What I was looking at was FY22, where I think they will have almost $1.1bn of sales after hedging, made up of:

$840m gas - (266000 MMcf x $3.17)
$142m NGLs - (4200 MBbls x $33.82)
$82m of oil - (1160 MBbls x $70.00) - I know they have oil hedged at $67.12, but only 70% of production.
$25m of midstream revenue.

The higher production volumes for oil and NGL in this calculation are because the Tanos and Tapstone acquisitions will be operational and in the production figures for 2022.

Am I missing something?

I think you are right about the dividend though - if I were Rusty I'd be increasing the dividend regularly but in small increments. The extra cash can be used to pay down debt or make bolt-on acquisitions (if assets are available at a sensible price).

Bumping this thread from October to point out that the published December exit rate of 139 Mboepd is supportive of my October estimate that DEC will produce around 265000 MMcf of gas in 2022.

At the published hedged price of $3.17 - this implies $850m of 2022 gas revenue after hedging - an improvement of $50m from what I previously thought. On the basis of the published hedge prices for oil and NGLs, DEC should have around $1.1bn of revenue *after hedging* in 2022.

They also look to have done a solid job controlling costs - total costs of $7.97/boe produced imply just under $350m of costs in 2021. If that cost per boe is reproduced in 2022 (and it might very well be lower!) then costs would stay under $400m.

Total hedged 2022 revenue of $1.1bn minus projected 2022 costs of $400m = EBITDA of $700m.

To me that would support a free cash flow of over $550m.
40% of this is $220m - which would potentially support a dividend of 25 cents per share!

Overall I think the Trading Statement tells us very little we did not already know or suspect about FY21.

But, looking forward into 2022, the confirmation of production rates, well decline figures, hedge prices, and the current cost base allow us to put some figures on what 2022 might look like. As previously suggested in October, I would not be at all surprised to see further dividend increases announced - perhaps with the annual results in March.

I think you've focused in on the $3.00 hedge level in my example a little too much. What Rusty (CEO) said was that Diversified is very, very cash generative when they are able to sell at an average price anywhere around $3.00. But a price of $2.90 (profit margin c. 55%) works almost as well as a price of $3.10 (profit margin c. 58%) for these purposes.

You are right that any unhedged volume is exposed to whatever the market price is at the point of sale - which *at the moment* is a positive thing. However, only a small fraction of DEC's production for FY22 is likely to be unhedged at this point, so movements in the gas price (in either direction) *shouldn't* have a big effect on FY22 revenue or results. Page 98 of the Capital Markets Day slide deck indicates how the hedging levels are ramped up over time.