Income shares are popular for investors seeking to build a passive income. And hunting down high-yield opportunities can potentially reveal lucrative possibilities. The FTSE 250 is known as the UK’s growth index. However, there’s a wide range of dividend-paying enterprises here. And thanks to ongoing market volatility, quite a few are now offering chunky payouts.
Top of the list are Diversified Energy Company (LSE:DEC) and Ithaca Energy (LSE:ITH). Both operate within the oil & gas industry, with yields standing at 19.8% and 12.8% respectively. But are these dividends too good to be true? Let’s take a closer look.
Expansion comes versus cost
Starting with Diversified Energy, the group owns a vast portfolio of oil wells and around 17,000 miles of pipelines in the US. While oil prices have risen since the end of summer, they’ve been on a downward trajectory over the past couple of weeks as the conflict in Gaza doesn’t yet appear to be affecting supply or demand in the Middle East.
This up-and-down motion in oil prices is creating quite a few headaches for most oil & gas extractors. However, in the case of DEC, the group’s hedge book seems to provide significant stability, protecting margins in the process.
As such, earnings are still rising by double digits, and the free cash flow yield makes the current level of dividend payments look sustainable, even at a near-20% yield!
Does that make it the best income stock to own right now? Unfortunately, no. While cash flow remains robust, it’s not adequate to fund management’s aggressive expansion strategy. Adding new wells is expensive. And with interest rates making debt less viable, equity is the next best alternative. In fact, the firm has already been issuing stock to raise expansion funds.
With the number of shares outstanding almost doubling in the last five years, the amount of equity dilution is quite strong. As a consequence, the dividends might be chunky, but the share price has suffered significantly for it. And this isn’t a trend I expect to change anytime soon.
An explosive growth opportunity?
Ithaca Energy is a relatively new addition to the London Stock Exchange, with shares only becoming publicly available a year ago. So far, its life as a public company isn’t off to a great start, with the stock dropping by almost a third in value. However, something interesting has just happened that might reverse the tide.
The Rosebank oilfield in the North Sea has just been given the green light by regulators after almost 20 years since its discovery. Why does this matter? Well, it’s the UK’s largest untapped source of oil & gas… and Ithaca owns 20%.
Working with Equinor, the company expects to extract an estimated 245 million barrels of oil from the first phase of development. At today’s prices, that’s around £16bn of potential revenue!
Needless to say, that’s quite a tailwind. But it’s worth keeping in mind that it will be several years before any profits materialise. Production isn’t expected to begin until 2026. And in the meantime, the group’s state of liquidity is a bit tight.
Management has made encouraging strides in reducing current debt levels. However, further capital may be needed to fund the development of Rosebank. And that might place dividends in jeopardy. Therefore, I’m keeping this business on my watchlist
