At 14.5%, is this share a high-yield bargain?

Our writer considers some pros and cons of a high-yield share with an innovative business model. Is he persuaded enough to purchase it?

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Income is one of the reasons I invest. High-yield shares can offer me some juicy dividend opportunities. For example, Henderson Far East Income is paying a 9.1% yield at the moment. So if I bought £1,000 worth of its shares today, I would hopefully earn £91 in passive income annually.

That is already a big yield. But it pales in comparison to Diversified Energy (LSE: DEC). Last week, the company declared its final dividend for its final year. With an annual dividend of 17c per share paid in four quarterly instalments, Diversified now has a dividend yield of 14.5%.

Should I snap it up for my portfolio?

Innovative business model

Diversified buys up old gas and oil wells. If it can do that cheaply but still pump gas from them for years or even decades, it could be snapping up a cheap source of energy that it can sell at the market rate.

The company is ramping up this potentially highly lucrative business model. It recently spent over half a billion dollars on acquisitions.

It has also increased the rate of well retirement. The potential costs in doing that across the estate of over 60,000 wells is a risk to the company’s business model and profitability. So I see it as positive news that Diversified has been retiring hundreds of wells “responsibly and efficiently” to use its own words.

Juicy dividend

The business has consistently raised its annual dividend in recent years giving it an unusually high yield. But does its business model suggest that that can continue?

One risk is a decline in energy prices. I think that would hurt both revenues and profits for the firm.

But another risk is the company’s ability to fund the dividends. Last year saw the net loss balloon to $620m. Negative cash flows were roughly $5m, after distributing $143m to shareholders as dividends.

The company’s financing is complicated. Last year, for example, it repaid $2.1bn of borrowings with one hand, but borrowed a further $2.6bn with the other.

So although the company made a huge loss last year, in fact its dividend was almost supported by free cash flows. That suggests that it could continue at a similar level or increase again, if the cash flows stay strong. Then again, those cash flows partly reflect the company’s enthusiastic borrowing.

High yield, with risks

Whether the cash flows will remain high remains to be seen, however.

Energy cost falls could mean less money comes in. The company has been borrowing heavily, which has boosted cash inflows. Net debt last year rose from $1.0bn to $1.4bn. With rising interest rates, borrowing may well become more expensive over time.

I think Diversified has an interesting business model and in recent years it has been a dividend gusher for shareholders. But I have doubts that the high yield can be sustained over the long term, especially if energy prices crash. I will not be buying the shares for my portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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