Even as UK shares reach new all-time highs, there are still plenty of high-yield income shares on offer. And when looking at the smaller players in the energy sector, some of these yields are on the verge of heading into double-digit territory!
Normally, such a high payout is a sign to steer clear, driven by a sudden drop in share price and eventually followed by a dividend cut. And yet, even with its yield now approaching 10%, Harbour Energy‘s (LSE:HBR) continues rewarding shareholders.
So is this an overlooked income opportunity? Or is there a reason why investors are avoiding the business?
Inspecting the dividend
In the world of independent oil & gas enterprises, Harbour’s one of the biggest, focusing on exploration and production. And following its recent acquisition of Wintershall Dea’s oil & gas asset portfolio, the firm’s expanded its geographical footprint to cover the UK North Sea, Germany, Argentina, Mexico, North Africa, and Southeast Asia.
This deal also allowed the business to drastically increase its production capacity. Prior to the acquisition, production volumes hovered around 180,000 barrels of oil equivalents per day (boepd). Today, the company’s on track to deliver as much as 475,000 boepd based on management’s 2025 guidance.
Following this 160% boost to production, the company’s promised to ramp up gross dividend payouts to $455m. And from a free cash flow perspective, this is actually more than affordable, suggesting the near-10% dividend yield’s here to stay.
Yet when compared to earnings, the payout ratio exceeds 200%, suggesting a cut’s imminent. What’s going on here?
What’s wrong?
The problem is the UK North Sea. Even after integrating Wintershall Dea assets, this region’s still responsible for around a third of the total group production. And with the UK government implementing a massive windfall tax on all production in this area, a massive chunk of Harbour Energy’s profits are subject to a 78% effective tax rate.
This is why Harbour Energy’s free cash flow‘s so high, yet net income’s so low. What’s more, this levy has already been changed, increased, and extended multiple times by multiple governments. So the fear among investors is that lawmakers will continue meddling, creating investment uncertainty.
What does this mean for dividends? So long as free cash flow generation’s robust, the company appears capable of maintaining its chunky yield. But suppose commodity prices start to tumble or the government decides to raise taxes even higher? In that case, management might be forced to break its promises. And given the ongoing volatility within the energy sector, most investors are seemingly unwilling to take on this risk.
The bottom line
Harbour Energy’s management is fully aware of the unfavourable North Sea tax environment. And its recent diversification efforts have helped reduce its reliance on production in this region. Nevertheless, the exposure’s still significant. And like most investors, the ongoing uncertainty doesn’t compel me to start buying shares right now.
So while there may be a lucrative dividend opportunity here. I think there are other lower-risk income shares worth exploring in 2025.
