Diversified Energy believes in US listing as a way to reignite its fire

Diversified Energy, which joined London’s junior oil and gas market seven years earlier, positioned itself as an unusual and unique prospect among the other oil-and-gas minnows. The American producer promised to give investors a bumper cash return, backed up by a constant stream of cash generated from the gas wells that were not loved by the energy giants.

Some analysts were skeptical about the assurance, even back then. But for a while, Aim defied their critics and grew its market value to £1.1 billion by 2022, from just over £70 million when it was admitted to Aim.

The company had been paying a generous dividend until March of this year, when it cut the payout. This was an apparent admission by the company that balancing a large debt repayment, a generous shareholder return, and feeding their acquisition pipeline would be too difficult.

The reset was announced just three months after the US Congress began to scrutinize the company’s environmental liabilities. There were concerns that the company may have “significantly underestimated well cleanup costs” when the gas production has been exhausted.

Since then, investors have shunned this company. Over the last two years, its share price fell by 70 percent. This caused it to be thrown out of the FTSE 250 index at the most recent reshuffle. On Tuesday, it fell another 25 1/2p or 2.8% to 894 1/2p.

Investors bet that the stock will continue to decline despite the company’s decision to reduce the dividend in order to relieve pressure on its balance sheet.

Rusty Hutson Jr., who was then working in finance and bought an old well in West Virginia, his home state, founded the company in 2001. The fourth generation in his family has made their money from oil and gas. Hutson explained, “I had the urge to start the business from scratch. I have always been an entrepreneur.”

The company is the largest gas well owner in America, with more than 70,000 gas wells, mainly in southern and Appalachian areas, and it has spent $2.6 billion in the last year. Hutson, the CEO of the group, has referred to the “dash to shale”, among US producers. The group acquired older wells to free up cash for drilling new discoveries.

Gas wells are the company’s largest asset in America. They are located mainly in the Appalachian and southern regions.

By investing in the extension of the life span of existing wells the company argues that it can increase the profit margins for a cheaper price than previous owners. It can then generate enough cashflow to pay a generous dividend to shareholders, to make debt payments, and to cover the costs of decommissioning the old wells.

The market is questioning Diversified’s capacity to handle the heavy burden. Hutson attributes Hutson’s sell-off of the shares, whose high yield attracted income investors, to the heavy outflows which have affected UK funds.

Hutson said, “We were caught in a very tough market for almost two years.”

When the decision was made in March to change the progressive quarterly dividend from 87.5 cents per share to a flat 29 cents per share, the yield had already reached alarming levels of 30%. The cash payouts were also higher due to the new shares issued in 2017 and 2018.

Hutson was forced to act by the New York listing the company received at the end last year. Hutson explained that they knew the company would be screened and that we’d have trouble finding US investors who’d say, “25-30%, something is wrong here”, if it was listed in New York.

But the perception of a company in trouble has stuck. One analyst stated: “I have always believed that there would be a reckoning. I believe that it is approaching now.”

The company generated free cashflow of $219 million last year after paying $117 million for interest and operating costs. This does not include dividends, debt repayments or the purchase of more wells.

Diversified, according to some analysts, must still maintain a delicate balance even though it has saved $110 million per year by reducing the dividend. Peel Hunt analysts predict that the company will only have $29 million left in cash this year. This figure will rise to $41 million the following year, and $58 millions in 2026. These estimates do not include any cash invested in acquisitions.

After three major deals in this year, the company said that its current focus was on “reducing leverage” and “driving value to shareholders”.

The company has used several options, including borrowing money from equity markets, issuing stock to the seller, and securitizing its assets. The company has used several options to finance its debt, including tapping equity markets, issuing shares to the seller, and securitising its assets.

Hutson hopes that leverage will be back to target by the end next year. He says he is “very satisfied with [the dividend] in the near future”, referring to debt at fixed rates of 80 percent. Diversified pays off its debt over a period between ten and fifteen years, instead of lumpy maturities. However, a steady drip-feeding of cash is required. Dividend yields are still around 10%, which is the highest in the industry.

The business is faced with more fundamental issues. Snowcap Research (a short seller based in London) accused the company, in a January report, of underestimating costs of decommissioning the wells.

The report disputes the rate of decline in production at Diversified wells. It puts it at 18% annualised, which is higher than the 10 percent “stable” rate the company reported. The report also said that Diversified’s estimate of the average lifespan of its wells is 50 years, but at the very latest 2095. At the end of June the undiscounted costs of plugging wells were $1.96 billion. However, when discounted over decades, this liability drops to just $507 million.

Diversified stated that the Snowcap report was “filled with numerous inaccuracies” and designed to negatively impact the company’s stock price, for their short position.

The company said that by owning an asset-retirement company, it could better control its costs. These are reviewed by the auditor of the company, along with the total asset retirement liability. The company’s track record is one of retiring wells safely, efficiently and in an environmentally friendly manner.

Snowcap is convinced that Diversified has vindicated its decision to reduce its dividend, and it maintains its short-position.

Four members of the House of Representatives also expressed concerns that the company underestimated well clean-up cost in a letter sent to Hutson one month earlier. They said that Diversified had more American wells directly under its control than any other firm and that, if it was unable to pay its environmental liabilities it “could result in thousands of orphaned methane-leaking shale wells, and undermine efforts to address the worsening of climate change”.

Hutson stated: “Let us be clear, this was a very small number of Democrat only Congressional members. It was a simple question and answer. There was no investigation. “There was no investigation.”

He said that the company had clear processes to track any methane leaking and answered all the questions in the letter.

Hutson thinks that the New York listing will help to regain momentum as the shares are stagnant.

The UK markets are very, very tough in relation to our industry. Let’s call it what is is, he said. “The US will rewrite shares to reflect the education about what we do and how we do it.”