Diversified Gas & Oil PLC (DGOC) is an Alabama, USA-headquartered operator of gas and oil producing assets with major business operations spread across Appalachian Basin since inception in 2001. The group has grown to become an established independent owner and operator in the Appalachian Basin, where the group produces natural gas & oil wells and is one of the largest independent conventional oil producers in the prolific Appalachian Basin. The operations of the group are densely located throughout the neighbouring states of Maryland, Pennsylvania, Ohio, West Virginia, Virginia, Kentucky, and Tennessee. The group is listed on the AIM market of the London Stock Exchange.

The group seeks to acquire and enhance its gas and oil producing assets in the Appalachian Basin with a focus on stabilising production from a significant midstream operation and a low-risk, long-life portfolio of wells. The group leverages the operating efficiencies that come with economies of scale as the assets base of the group consists of approximately 99.7% conventional gas and oil producing assets. The wells of the group require low ongoing capital expenditures and benefit from simple and low-cost maintenance operations as they produce from shallow-depth, vertical wells, leading to a high-quality and reliable stream of free cash flow. The assets of the group are located in politically, and geologically low-risk gas and oil basin, and more than 95% of proven reserves are classified as Proved Developed Producing.

Key Statistics


Management
David Johnson is the Non-Executive Chairman of the group. Rusty Hutson, Jr. is the Chief Executive Officer and Co-Founder of the company. The CEO is supported by Brad Gray, who is the Chief Operating Officer and Executive Vice President.

Top Shareholders
 
(Source: Thomson Reuters)

Recent Development
The company on 25 July 2019 announced that it had entered into a stalking-horse Asset Purchase Agreement with EdgeMarc Energy Holdings for $50 million, which will be financed from the existing liquidity of the group. According to the agreement, the company will assume certain related liabilities and acquire certain Ohio-located oil and natural gas development, production and exploration assets, subject to necessary approvals and conditions under the Bankruptcy Court-supervised process. The group expects to make a further announcement on or before 29 August 2019, and there is no certainty at this point that the transaction will be completed as the deal will have to follow the Court-mandated process.

Share Buyback Programme
The company on 30 April 2019 announced that the Board had approved the terms of a share buyback programme, which is intended to reduce the share capital of the company and would be undertaken by Stifel Nicolaus Europe Limited on behalf of the company. From time to time, depending on market conditions and other factors, the group would purchase its shares in open market transactions with an aggregate market value of up to $68.2 million.

Financial Highlights (H1 FY 2019, in $m)
 
 
 (Source: Company Filings)

Driven by the full integration of the previously acquired EQT and Core assets in the second half of 2018 and the HG Energy assets in the first half of 2019, the company ended the period with net MBOE sales of approximately 13,701 versus the prior year sales of approximately 3,499. This acquisitive growth strategy positively impacted the production and increased midstream revenue, which helped in increasing total revenue in 1H19 to $237.5 million, reflecting an increase of 309.2% from the $58.0 million reported for 1H18, while total natural gas, NGL and oil revenue rose by 294% to $223.3 million. Average daily production grew by 291.5% over the year to 75,696 BOE/day from 19,333 BOE/Day (H1 FY18), where the share of gas (BOE basis) reduced to 89% in H1 FY19 from 95% in H1 FY18. Average realised sales price (excluding the impact of cash-settled derivatives) remained largely flat over the year at $16.30 against $16.20 in H1 FY18, while average realised sales price (including the impact of cash-settled derivatives) rose by 4.73% to $16.84 from $16.08 in H1 2018, indicating the favourable impact of the hedging programme. Through a mixture of disciplined cost reductions and economies of scale, driven by significant growth in the production base, unit operating expenses decreased by 9% or $1.10 per BOE to $11.84 from $12.94 in the corresponding period of last year. Due to the increase in borrowings used to fund the acquisitions, interest expense on borrowings increased by $12.3 million to $15.7 million in 2019 compared to $3.4 million in 2018. Gross profit for the period grew to $97 million against $20.2 million last year, while operating profit increased to $107.7 million versus $36.1 million in the prior year. The group reported operating income per BOE of $9.58, up by 46.5% over the year, with an operating margin of 53.6%. Income before taxation grew by 293% over the year from $21.4 million in 1H18 to $84.0 million in 1H19, while income after taxation available to ordinary shareholders was $62.1 million, corresponding to statutory earnings per share (basic and diluted) of $0.10 in 1H19 against $0.09 per ordinary share in 1H18. The adjusted EBITDA for 1H19 reported an increase of 474% over $22.87 million in 1H18 to $131.3 million, while adjusted EBITDA per ordinary share (basic and diluted) grew by 144.44% to $0.22. Despite a period of lower natural gas and natural gas liquids prices, cash margins in 1H19 remained consistent with 1Q19 at approximately 54%, and the group increased its borrowing base to $950 million.

Financial Ratios

(Source: Thomson Reuters)

Ratios Commentary
In the latest half-yearly results, the gross and EBITDA margin rose year on year but were below the industry median. The net margin and return on equity have declined over the year and have started to normalise towards the industry median. The current ratio was considerably higher than the industry and increased as compared to the last year. The company was more leveraged than its peers, but the debt/equity ratio declined in comparison to the previous half-yearly result. Asset turnover ratio remained constant in contrast to last year and was higher than the industry median.

Valuation Methodology
Method 1: EV/SalesMultiple Approach (NTM) 

To compare DGOC with its peers, EV/Sales multiple has been used. The peers are SOCO International PLC(NTM EV/Sales was 0.75), Gulf Keystone Petroleum Ltd(NTM EV/Sales was 1.71), Cairn Energy PLC(NTM EV/Sales was 2.73),Nostrum Oil & Gas PLC(NTM EV/Sales was 2.80) and Phoenix Global Resources PLC(NTM EV/Sales was 5.38). The mean of EV/Sales (NTM) of the company’s peers was 2.68x (approx.).

Method 2:Price/Earnings Multiple Approach (NTM)

To compare DGOC with its peers, Price/Earnings multiple has been used. The peers are Phoenix Global Resources PLC(NTM Price/Earnings was -15.64), Nostrum Oil & Gas PLC(NTM Price/Earnings was 2.52), Gulf Keystone Petroleum Ltd(NTM Price/Earnings was 7.06),Cairn Energy PLC(NTM Price/Earnings was 19.07),and SOCO International PLC(NTM Price/Earnings was 19.42). The mean of Price/Earnings (NTM) of the company’s peers was 6.49x (approx.).

Share Price Commentary

 Daily Chart as at 14-August-19, before the market closed (Source: Thomson Reuters)

On 14 August 2019 (at the time of writing, GMT 8:40 AM), DGOC shares were hovering at GBX 98.65, up by 0.66 per cent against the previous day closing price. Stock's 52 weeks High and Low is GBX 135.00/GBX 94.32. Stock’s average traded volume for 5 days was 1,484,080.20; 30 days – 1,830,532.03 and 90 days – 2,588,322.53. The average traded volume for 5 days was down by 18.93 per cent as compared to 30 days average traded volume. The company’s stock beta was -0.38, reflecting inverse relationship with the benchmark index. The outstanding market capitalisation was around £684.06 million, with a dividend yield of 10.99 per cent.

Risks Assessment and Growth Prospects
The growth and future success of the company are dependent on the successful completion of expansion strategies proposed, but future development and results of operations might be adversely impacted if the group is unable to manage the expansion effectively. Regardless of operating performance, financials of the group can be adversely affected by changes in commodity pricing, currency exchange fluctuation, and economic and political events. Moreover, changes in market prices can lead to fluctuations in the future cash flows or fair value of assets. In the long run, the products of the group are also under threat of getting replaces from renewable sources of energy and environment-friendly applications. However, even in an environment of lower commodity pricing, the company has been able to generate strong free cash flow as it seeks to manage risk through long-term agreements and hedging. The policy of the group is to use 40% of free cash flow to pay down debt and maintain low leverage, while another 40% is targeted to be returned to shareholders in reliable quarterly dividends form. Through the acquisitive growth strategy undertaken by the group, it has successfully achieved higher production and an increase in midstream revenue. By lowering costs through deploying new extraction technology and deploying rigorous field management programs, the company seeks to maximize output from its portfolio in an efficient way. The group is also trading near its 52-week low, offering investors a good opportunity to enter the market.

Conclusion
To supportthe long-term growth objectives, the company delivered a number of key operational and strategic milestones and maintained a healthy financial footing by reducing debt. The group maintained a robust cash margin as all key cost metrics reported a decline, reflecting cost reduction due to the completion of the HG Energy acquisition. The group reported that it was performing in line with market expectations and seeks to continually create long-term, sustainable value.
 
Based on the decent growth prospects, and supported by valuation undertaken using the above two methods, we have given a “BUY” recommendation at the closing price of GBX 98.00 (as on 13 August 2019) with single-digit upside potential based on 6.49x NTM Price/Earnings (approx.) on FY19E earnings per share (approx.) and 2.68x NTM EV/Sales (approx.) on FY19E sales (approx.).
 
*All forecasted figures and Peer information have been taken from Thomson Reuters.

* The Buy recommendation is also valid for the current price as on August-14-2019.

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