I noticed the other day that Diversified Energy Company (LSE:DEC), the FTSE 250 American natural gas producer, has one of the highest yields of any UK share.
Out of curiosity, I decided to take a closer look at the group’s numbers. But I soon got confused by the various adjustments made when reporting its results.
Don’t get me wrong, it’s not alone in presenting its financial information in this way. Numerous companies make reference to various ‘adjusted’, ‘basic’, ‘core’, and ‘underlying’ financial measures.
And all of these businesses are trying to be more open and transparent by removing one-off items that aren’t expected to reoccur or reverse the impact of more obscure accounting adjustments.
But perversely, sometimes the position becomes more confused.
Trying to see the wood for the trees
For example, prior to investing, I reckon most would probably want to know whether Diversified Energy was profitable in 2024.
Unfortunately, it made a loss of $87m. Not good.
But hang on, its adjusted EBITDA (earnings before interest, tax, depreciation, and amortisation) was $472m. Much better.
Then again, its pro-forma (like-for-like) adjusted EBITDA was $549m. That’s only half of its current (12 May) market cap.
However, the use of EBITDA is controversial. Warren Buffett once said: “Does management think the tooth fairy pays for capital expenditures?”
Indeed, the group itself is cautious. It says adjusted EBITDA should “not be considered in isolation” or be used as a substitute for other measures. But it says it’s “useful to investors” because it’s widely used in the industry and removes potentially volatile items.
What else could we look at to assess the company?
Cash is king
Well, it’s often said that cash doesn’t lie. After all, it either exists or it doesn’t.
In 2024, the group reported free cash flow (FCF) of $170m.
But its adjusted FCF (including the proceeds from land sales) was $211m. Encouragingly, it’s similar to previous years – $247m (2023) and $220m (2022). And importantly for income investors, it’s comfortably more than the $70m that the 2025 dividend’s likely to cost.
My verdict
I’m not picking on Diversified Energy. In fact, I like the group’s business model, which can be summarised in five words – acquire, optimise, produce, transport, and retire.
It buys fields that are coming to the end of their lives. It then invests to improve their operational performance and prolong their production window. Most of the gas is sold and delivered to industrial and commercial customers at pre-agreed prices.
For 2025, recently completed acquisitions are expected to lift adjusted EBITDA to $825m-$875m and generate FCF of $420m.
However, its borrowings are high. At December 2024, its net debt was three times pro-forma adjusted EBITDA, comfortably above its target of 2.5.
Also, some have said the company is under-estimating the cost of retiring its wells.
But the demand for natural gas continues to rise and President Trump wants the industry to produce more. This should help the group’s medium-term earnings.
And then there’s the dividend. In March 2024, when it was cut by two-thirds to $0.29 a quarter, the company said: “This fixed quarterly dividend payment will be sustainable for at least three years.” On this basis, the stock’s currently yielding an impressive 8.8%.
These could be reasons for investors to consider adding Diversified Energy Company to their long-term portfolios.
