At 16.5%, this dividend stock has the highest yield in the FTSE 350

High-yield dividend stocks can generate impressive levels of passive income if they’re sustainable. Is this 16.5% payout too good to be true?

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The UK’s home to a vast range of dividend stocks. And while the yield typically sits close to around 4%, there are some companies offering considerably more.

Right now, Ithaca Energy (LSE:ITH) holds the crown for the most generous payout among FTSE 350 companies. The gas exploration and production company currently offers investors a whopping 16.5% yield at its current share price. And this payout may be set to grow considerably in the long run, given the game-changing deal it signed with Eni earlier this year.

A new player in town

In a £754m deal, Ithaca is buying almost all of Eni’s oil and gas assets, making it one of the largest independent energy companies operating in the North Sea. Subsequently, management expects to be producing an average of 80,000-87,000 barrels of oil equivalents a day in 2024.

By the early 2030s, this output could rise to as high as 150,000 barrels, giving the firm ample capacity to continue its generous dividend policy. In fact, management already anticipates paying up to $500m (£394m) in dividends this year as well as in 2025, funded by the expected increase in production.

What’s more, it seems the credit rating agencies are also becoming potentially more bullish about this enterprise. The firm’s officially under review for a potential debt rating upgrade from Moody’s and Fitch directly as a result of the Eni deal. And with a higher rating, the cost of future capital will naturally fall.

Keeping excitement under control

This deal is undeniably transformational. However, it’s important to note that it hasn’t actually happened yet. If everything goes according to plan, Eni and Ithaca will complete the transaction by the third quarter of 2024. But that also means a massive round of shareholder dilution could be on its way. After all, it’s being funded using equity rather than cash or debt.

Some of this dilution appears to already be baked into the stock price. And it’s undoubtedly a key reason why the yield has jumped into double-digit territory. But even after this merger of assets is completed, Ithaca’s still far from a risk-free enterprise.

Don’t forget its primary products are commodities. And the price of these is ultimately determined by the market, resulting in zero pricing power. This doesn’t matter all that much when oil and gas prices are high. But should they take a sudden turn for the worse, then the fixed-cost nature of oil & gas exploration and production can decimate margins.

Another threat to consider is political. As things stand, Labour’s on track to winning the next general election. Assuming the polls are correct, that means energy companies like Ithaca will have to operate under Labour rule for up to five years. And the party isn’t exactly a fan of the non-renewable energy industry.

To buy or not to buy?

From a dividend perspective, Ithaca appears to be one of the rare cases where a double-digit yield’s sustainable. However, even with this, the overall return on investment could prove lacklustre if the share price continues to trend downwards.

That’s why, despite its potential, I’m not tempted to capitalise on this income opportunity. But for investors with a higher tolerance to risk, Ithaca may merit a closer look.

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.

Zaven Boyrazian 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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