Member Info for MillerJackson

Dazzle - that's not quite what I meant. As I understand them, the Company's hedging arrangements mean that the Company will be highly profitable *whatever* happens to the gas price in FY2022 and FY2023, because the Company produces gas at a cost of around $1.30/Mcf (in H1 2021), and (post-hedging) will be able to sell it at an average price somewhere between $2.80 and $3.00. I am interested to hear confirmation of this last point from the Company in the upcoming trading update.

However, further increases in the gas price will probably add very little (certainly to FY2022, which I imagine is very likely 90%+ hedged by now).

Dazzle - I'm not quite sure I understand your question, but I think you are asking about the mark to market 'losses' and how they compare to the extra money that would be made from higher gas prices?

If so, 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.

The (newly increased) dividend is 4.25c per quarter - 17c per year, so about 12.5p.
So it is considerably north of 10% dividend yield at the current 107p price.

As a potential new holder, you should be aware that - if you are in the UK (or presumably anywhere outside the US) there is a US withholding tax on the dividend. You can fill in a W-8BEN form which reduces it to 15% if you hold in an ISA, or 0% in a SIPP. However, you would be well advised to check with your broker beforehand if they are able to action this for this company. Some, like iWeb, can't. Even deducting 15% tax (my situation) the yield is almost exactly 10% at the current price.

My own view is that the dividend is highly sustainable. The volume of gas produced and sold (and the cost per unit) is very predictable year-to-year. The well decline rates are published, and you can easily make assumptions from those (i.e. the reasonable worst case scenario might be that production volume is 8% less than last year, assuming there are no bolt on acquisitions).

So the main variable in terms of cash flow is the price at which DEC sell. This is heavily hedged, which has meant that DEC has largely not participated in the upside of the very high 2021 prices. They have, however, locked in sales at higher prices via hedging for future years to come, and the CEO says that the Company "makes a tonne of cash" if they can sell at $3 or higher. We experienced a very low price environment in 2020, and the Company came through it well - which leads me to believe they will do so again if gas prices should reduce for any reason.

Plainly the risks of investing in hydrocarbon companies apply to DEC. However, the company's actual business of producing and selling gas is going great guns as far as I can tell, and if they are left largely alone by the US government it should continue to do so.

The upcoming annual accounts for FY21 will no doubt show three things:

1) a flourishing gas business, with efficient production, sky high margins, and monumental amounts of cash generated; and
2) significant offset of that profit by the 2021 hedges, but still leaving lots of cash; and finally
3) enormous paper losses due to 'mark to market' accounting on the hedge portfolio covering 2022-2027.

(3) will be potentially scary for new investors and those who don't really follow the company closely - but ultimately it is an irrelevance - a quirk of the accounting requirements that the Company is required to mark down losses in respect of (for example) the current value of the 2024 hedges, but these 'losses' aren't permitted to be offset by the expected sale of gas in 2024!

Nice to see the shares heading back up today though!

Andy144, if your prediction comes to pass re: putting money aside for capping unproductive wells then that's plainly a better position than the 'worst-case scenario' I outlined of having to cap 7000 non-producing wells, so would be dealt with more comfortably by DEC.

I think it's clear from the Capital Markets Day that the Company is committed to minimising methane leaks anyway. In my view, DEC is taking all the right steps to become the best-in-class operator of these types of wells from an environmental point of view as well as from a production perspective.

For these reasons, I think investors will eventually come to see that DEC is a good news story in terms of environmental impact. These wells have already been drilled, and the best environmental outcome is for them to be owned by a reputable and financially sound company with the desire, funds, and technical ability to prevent methane leaks, and to meet their capping obligations over time.

While legal & regulatory change may impose certain higher costs on DEC, it's important to recognise that these costs would affect the whole industry, not only DEC. In particular, this would likely lead to a buyer's market for DEC when making new bolt-on acquisitions: there would be some motivated sellers out there, where existing owners do not have the same funds or the same expertise.

So the effect of potentially increased regulation is not all negative for DEC, there is upside too.

Hi Andy,

Not sure if this is what you are after, but the August 2021 'Asset Retirement Supplement' published on the company's website sets out the asset retirement decision tree (p3), and the number of Operated Wells (62,000) and Total Wells (69,000), on p10.

Therefore there are around 7000 wells which were not being operated in August 2021 (although this does not necessarily imply they are all not capable of being operated).

To me, the worst case scenario in this area is that legal/regulatory change could require gas producers (including DEC) to rapidly cap these non-producing wells. Realistically, some time would have to be allowed for this - couple of years at least.

But even in this worst-case scenario, it seems to me that the immediate cost to the company would only be about 7000 wells x $25,000 cost per well = $175m. Presumably spread among at least 2 financial years.

In the context of the brokers pointing towards FCF of $400m+ for FY22, this implies that even the very worst case scenario for immediate capping would be a cost of about 22% of predicted FCF for FY22 & FY23.

Or, hypothetically, if the whole of the money for capping 7000 wells was deducted from dividend payments to shareholders (which I don't believe would be the case at all), then the company would still have £113m to return to investors over FY22 and FY23 combined - i.e. about 13 c, a yield of 5% or so.

These numbers suggest to me that any potential changes to federal/state capping requirements - while plainly an inconvenience to the whole gas industry - could be overcome by DEC reasonably easily over the course of a couple of years.

I don't know if you dialled in to the Capital Markets Day yesterday, but I did - and was pretty impressed by management. I'm mid-30s, so I don't know if you are aiming for a younger generation even than me!?

My view is that a key strength of the company is that they have a lot of industry experience amongst management. This logically means that they will be older, and (in practice given the Company's operating area), whiter.

Given that the DEC management team have delivered significant, transformative growth to date, I'd suggest it would be hugely counter-productive to sack able people who are delivering results, based on nothing more than a perception that they are too old (or too white).

It's just a very good piece of business all round really. Although it's small in relation to the whole Company, it's a substantial portion of that Tanos acquisition (30%) already recouped.

It's core to DEC's business model that they will continue to be able to purchase wells at a sensible price. If they are able to consistently flip the undeveloped assets within a purchased portfolio, this reduces net cost of their acquisitions. I wonder if there are more undeveloped assets (relating to the other recent acquisitions) which DEC could sell too. I'm sure they are looking into it.

More generally, the Biden administration's leak proposals suggest that there may be some motivated sellers in future - so possibly nice low acquisition multiples for DEC even in a high gas price environment.

A very helpful development - a $37m sale of undeveloped acreage acquired alongside Tanos.
Gives the company more firepower to make bolt-on acquisitions in the short term.

More importantly, it's a precedent for being able to reduce the effective cost of acquisitions by selling on undeveloped resources. Just because DEC do not ascribe any value to undeveloped reserves when purchasing, doesn't mean there is not substantial value which can be realised by an onward sale - especially in this price environment.

Great news. I've just topped up.

In a word, no, because you are not taking dividends from a fixed pool of cash which declines. The share price reflects the value of the company's net assets plus the current value of estimated future profits - even when a company pays a dividend, although the company's assets reduce by the amount paid out, the company soon replaces these assets via ongoing trading, and still has future profits which are unaffected by the dividend.

A better way to think about it is that the price immediately before the ex-div date is higher than it otherwise would be, to reflect the fact that holders will shortly be paid the dividend amount, the fall on the ex-div date reflects that this is no longer the case.

Thanks. The Cenkos note was very useful. In particular, I'd not appreciated that the new Tapstone acquisition produced quite a bit of oil and NGL, so it will boost FY22 revenue by much more than I had realised.

The only thing that gives me pause from accepting Cenkos' FCF prediction of $455m is that they report the company's free cash flow actuals as being minus $3m in 2020 and minus $192m in 2019. I cannot understand how they have reached this number when DEC's 2020 Annual Report stated (on p214) that FCF was $247m for 2020, and $220m for 2019 !

I can only think that Cenkos and DEC are not using the same definition of Free Cash Flow...which undermines my confidence in the $455m figure estimated by Cenkos.

But I agree that FCF should be significantly better than the £380m that I calculated before.
I'd be surprised if FCF wasn't over $410m.

The Cenkos suggestion that dividends will actually *reduce* to 16c from 16.41c is really very peculiar, especially in the light of this dividend increase. I'm baffled. Any thoughts?

I certainly hope that the company will give a clear steer as to their dividend policy at the Capital Markets Day in November. Hopefully they will also confirm that there will not be any more placings.

That's interesting - I've seen references to the Cenkos note, and their price target of 176p, but haven't had the benefit of seeing a copy. My calculations were pretty conservative as regards operating & administrative expenses. Cenkos are in a better position to accurately estimate those numbers.

As you say, if FCF is $456m, then the dividend could be up to 21.4 cents, which at 9% yield implies a share price of 172p.

Interestingly, given the current exchange rate (0.725) and shares in issue (850m), the price target for a $2bn market cap (and likely US listing) is 170p.

I very much doubt that this is the last dividend increase. The Tanos acquisition will be fully on-line next quarter, and the Tapstone acquisition for Q1 2022. Even allowing for the 9% decline rate, this implies that DEC will be producing around 265000 MMcf of gas in 2022, which at a hedged price of $3.02 implies revenue of c. $800m from hedged gas sales alone.

Adding oil at $61.50 hedged, NGL at $30.11 hedged, and midstream revenues of $25m, implies revenue of $950m in 2022.
Even if DEC is unable to immediately make the efficiency savings it plans, this still implies Free Cash Flow of over $380m.

Given the dividend policy is to pay c. 40% of Free Cash Flow - this suggests there should be about $152m paid out in dividends - which is almost 18 cents per share. So, I am expecting that the dividend will be increased to 4.5c per quarter at some point in 2022.

If you assume that the yield will go no lower than 8%-9%, that implies a share price between £1.45 to £1.62
Which would give a market cap of around USD 1.7bn to 1.9bn...
i.e. pretty close to the $2bn that Rusty thinks is optimal to proceed with a US listing.