With many FTSE 250 stocks still recovering from the recent correction, there continue to be many buying opportunities for investors to take advantage of. And a quick glance at valuation metrics throughout the index reveals one firm in particular that looks dirt cheap.
Despite having one of the largest oil & gas well portfolios in the United States, Diversified Energy Company (LSE:DEC) currently trades at a price-to-earnings (P/E) ratio of just 0.7. For reference, the market average is around 15.
Is this one of the greatest buying opportunities of 2024? Or is there a reason why this business is being priced so cheaply? Let’s take a closer look.
A reliable 23% dividend yield?
Shares of Diversified Energy Company have had a pretty rough time lately. In fact, they’ve fallen by over 50% across the last 12 months. As a result, the firm’s dividend yield has shot up to absurdly high levels. So much so that it looks entirely unsustainable on the surface. Yet the underlying financials paint a very different picture.
Even in the weakened oil & gas market, the group’s hedge book against fluctuations in commodity prices has kept the profits rolling in. In fact, underlying earnings have jumped 26% as per its 2023 interim results, reaching $283m. And this growth appears to have been maintained in its latest third-quarter trading update.
Free cash flow generation also continues to provide ample coverage to support its 23% dividend yield. So much so that analysts from investment bank Peel Hunt described it as among the most secure in the entire sector.
It seems Diversified Energy Company is a rare combination of improving financials and falling share price at an extreme level. If this pessimism is unfounded, snapping up shares today could be a very good move. However, there may be good reason to exercise caution.
Government investigation
There are a lot of factors influencing the company’s share price. Equity dilution is certainly responsible for some of the decline as management seeks to raise capital to fuel expansion. But, the primary point of concern is the revelation of a potentially catastrophic government enquiry.
Allegations have been made that the firm is not taking the proper steps required to seal up mature wells. The result is the escape of methane gas. This leakage represents a massive environmental threat. And with over 65,000 wells in the firm’s portfolio, concerns have made their way to the House Committee on Energy and Commerce in the United States.
This culminated in a nine-page letter sent to the company asking for information about methane leakage that could cost billions in clean-up costs in the long run if not correctly handled today. This revelation was understandably shocking, given Diversified Energy had just received an award from ESG Awards Europe and a Gold Rating from the Oil & Gas Methane Partnership (OGMP).
Management vehemently denies the allegations. And is cooperating with the enquiry to prove its responsible approach to retiring mature wells. However, if it’s proved that methane leakage is a widespread issue throughout the business, the legal penalties in the coming years could be disastrous.
With this in mind, buying shares today seems more like speculation rather than investment. The risk is simply too high for my tastes. And therefore, even at the dirt cheap valuation, it’s not a stock I’m tempted to add to my portfolio right now.
