The FTSE 250 is home to many mid- and small-cap growth companies. However, it also houses its fair share of dividend-paying enterprises. And right now, Diversified Energy Company (LSE:DEC) has one of the highest yields on the London Stock Exchange at a whopping 30%!
Typically, seeing a payout this high is a giant red flag. It’s almost always a guaranteed signal that the shareholder payouts are on the verge of getting cut. But last week management confirmed it’s returning $45m of capital to shareholders either as a dividend or through a tender offer to buy back its own shares subject to investor preference.
What on Earth is going on? And with the ex-dividend date still just over a week away, should investors be rushing to snap up this enormous payout?
A looming environmental disaster?
For a bit of context, Diversified Energy owns and operates one of the largest oil & gas well portfolios in the US, along with pipelines and other energy-related infrastructure. As a key supplier, it serves as a critical player within this industry. So why have the shares collapsed by nearly 60% in the last 12 months, resulting in a price-to-earnings ratio of 0.55 and its gargantuan yield?
There are a few factors at play. However, the primary catalyst behind this volatility appears to have started following a new government enquiry. Reports have come in that the company isn’t taking the proper steps to plug its retired wells correctly, resulting in the release of methane gas into the atmosphere.
It’s important to note that these allegations have yet to be proved, and the firm fervently denies any wrongdoing. But with the cost of the clean-up potentially ranging into the billions, it seems many shareholders are jumping ship regardless.
It also doesn’t help that Diversified has unsurprisingly found itself under fire from short-sellers. Snowcap Research recently published a new report citing new satellite measurements. And these revealed methane emissions coming from Diversified Energy’s retired wells being 16 times higher than what the company reported.
Having said that, it’s hard to know whether Snowcap has been cherry-picking data. Don’t forget, it has an invested interest in the share price dropping. And that could influence the short report.
The best bargain buying opportunity of the year?
Whether this FTSE 250 enterprise is a good stock to buy ultimately depends on how true the allegations made against it are. The group’s reported cash flows certainly suggest the underlying business remains on track. And with its extensive hedge book protecting the bottom line from fluctuations in oil and gas commodity prices, Diversified Energy looks to be in good shape.
It would seem management agrees. After all, it intends to buy back its own stock at a premium to capitalise on its cheap-looking valuation. And with seemingly no plans to cancel its upcoming $45m return of capital, the 30% yield looks sustainable for now.
Unfortunately, that could all change if this methane problem turns out to be a widespread one. The costs of fixing such an issue, along with the legal penalties, would likely be severe. So much so that it might bankrupt the entire business. Therefore, I think some caution is definitely warranted when considering this stock.
