Diversified Gas & Oil PLC (DGOC), an Alabama, USA-headquartered, AIM-listed owner and operator of producing natural gas & oil assets, is one of the largest independent conventional oil producers in the prolific Appalachian Basin. The operations of the group are focused on the Appalachian Basin since its inception in 2001, where the group produces natural gas & oil wells and has grown to become an established independent owner and operator. The operations of the group are densely spread throughout the neighbouring states of Maryland, Pennsylvania, Ohio, West Virginia, Virginia, Kentucky, and Tennessee. The group is a constituent of the FTSE AIM UK 50 Index.

The group focuses on stabilising production from a significant midstream operation and a low-risk, long-life portfolio of wells and seeks to acquire and enhance its gas and oil-producing assets in the Appalachian Basin, which are located in politically, and geologically low-risk gas and oil basin. The group leverages the operating efficiencies that come with economies of scale as the assets base of the company consists of approximately 99.7% conventional gas and oil-producing assets, and more than 95% of proven reserves are classified as Proved Developed Producing. 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.

Key Statistics


Management

David E. Johnson is the Non-Executive Chairman of the group and has a long career in the investment sector. Rusty Hutson, Jr. established Diversified Gas & Oil in 2001 and is currently the Chief Executive Officer of the group. Brad Gray joined the group in October 2016 and is the Chief Operating Officer and Executive Vice President of the group.

Top Shareholders

 
(Source: Thomson Reuters)

Recent Developments

The company on 12 September 2019 announced that it intends to formally pursue a move to the Premium Segment of the Main Market of the London Stock Exchange, from its current status at the AIM market, reflecting the growth of the company since its IPO in February 2017. Further, the company on 25 July 2019 announced that it has 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. The acquisition was completed on 18 September 2019.

Financial Highlights (H1 FY 2019, in $m)

 
(Source: Company Filings)

As the HG Energy assets acquired in the first half of 2019 and EQT and Core assets acquired in the second half of 2018 were fully integrated during the period, the company ended the period with net MBOE sales of approximately 13,701 versus the prior year sales of approximately 3,499.Total natural gas, NGL and oil revenue rose by 294% to $223.3 million, while theacquisitive growth strategy positively impacted the production and increased midstream revenue, which helped in increasing total revenue in H1 2019 by 309.2% from the $58.0 million reported for H1 2018 to $237.5 million. Asnet production of natural gas rose by 266.63% to 73,196 BOE/day, average daily production grew by 291.5% over the year to 75,696 BOE/day from 19,333 BOE/Day, and the share of gas reduced to 89% from 95%. Average realised sales price (excluding the impact of cash-settled derivatives) remained largely flat over the year at $16.30 against $16.20, 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 and helped by the completion of the HG Energy acquisition, unit operating expenses decreased by 9% or $1.10 per BOE to $11.84 from $12.94 in the corresponding period last year. Despite the lower natural gas and natural gas liquids prices throughout the period, the reduction in costs helped the group to maintain a robust cash margin of 54% through the first half of the 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 H1 FY2019 compared to $3.4 million in H1 FY2018.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, increasing 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 H1 2018 to $84.0 million in H1 2019, while income after taxation available to ordinary shareholders was $62.1 million, corresponding to statutory earnings (basic and diluted) of $0.10 in H1 2019 against $0.09 per ordinary share in H1 2018. The adjusted EBITDA for H1 2019 reported an increase of 474% over $22.87 million in H1 2018 to $131.3 million, while adjusted EBITDA per diluted ordinary share grew by 152% to $0.22. For the second quarter, the company declared a dividend of 3.5 cents per share (2Q18: 2.8 cents per share), in addition to the dividend payment of 3.42 cents per share in the first quarter. The company noted that $59 million had been returned to shareholders since the start of this year and almost $100 million in dividends declared have been returned since its admission to the AIM market.

Key Performance Indicators (FY 2018)

In the financial year 2018, the company increased its production by 521% to 41.0 MBOE/Day from 6.6 MBOE/Day reported in the prior year, while proved-developed-producing reserves rose by 762% to 474 MMBOE. The company also aims to grow through accretive acquisitions, which wasreported at $938 million, up by 957%, while acres held by production grew by 388% to 7.8 MM Acres. Unit lease operating costs reduced by 31% to $4.83 from $7.02 in 2017, while unit recurring G&A was down by 34% to $1.34.

Financial Ratios

 
(Source: Thomson Reuters)

In the latest half-yearly results, the gross and EBITDA margin was 40.8% and 52.2% respectively, indicating a year on year growth but were below the industry median. The net margin and return on equity have declined over the year, as the revenue has increased considerably over the years, and have started to normalise towards the industry median. The current ratio was substantially higher than the industry and improved as compared to the prior period. The company was more leveraged than its peers, but the debt/equity ratio declined in comparison to the previous half-yearly result and assets/equity was better than the industry. Asset turnover ratio remained constant in contrast to last year and was higher than the industry median, suggesting optimal utilisation of resources.

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



To compare DGOC with its peers, EV/Sales multiple has been used. The peers are International Petroleum Corp(NTM EV/Sales was 1.24), Premier Oil PLC(NTM EV/Sales was 2.54), Nostrum Oil & Gas PLC(NTM EV/Sales was 2.68),Parkmead Group PLC(NTM EV/Sales was 3.01), Cairn Energy PLC(NTM EV/Sales was 3.50), and Phoenix Global Resources PLC(NTM EV/Sales was 5.16). The mean of EV/Sales (NTM) of the company’s peers was 3.02x (approx.).

Method 2:Price/Earnings Multiple Approach (NTM)



To compare DGOC with its peers, Price/Earnings multiple has been used. The peers are Independent Oil and Gas PLC(NTM Price/Earnings was -15.07), International Petroleum Corp(NTM Price/Earnings was 5.44), Etablissements Maurel et Prom SA(NTM Price/Earnings was 6.19),Premier Oil PLC(NTM Price/Earnings was 7.58),Gulf Keystone Petroleum Ltd(NTM Price/Earnings was 7.78), Amerisur Resources PLC(NTM Price/Earnings was 9.81), and Cairn Energy PLC(NTM Price/Earnings was 23.85). The mean of Price/Earnings (NTM) of the company’s peers was 7.94x (approx.).

Share Price Commentary


Daily Chart as at 30-September-19, before the market close (Source: Thomson Reuters)

On 30 September 2019, at the time of writing (before the market close, at 8:30 am GMT), DGOC shares were trading at GBX 109.50, down by 0.45 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 811,269.40; 30 days – 924,268.37 and 90 days – 2,098,428.26. The average traded volume for 5 days was down by 12.23 per cent as compared to 30 days average traded volume. The company’s stock beta was -0.26, reflecting a weak and inverse relationship with the benchmark index. The outstanding market capitalisation was around £725.82million, with a dividend yield of 10.03 per cent.

Risks Assessment and Growth Prospects

The prices of various commodities which the company markets and produces can be subject to significant fluctuations, and as the prices are affected by global supply and demand, the company does not have any influence on the market prices, which can lead to a significant impact on the financials and affect the business assumptions. Moreover, the company has undertaken aggressive acquisition strategy in the last year which may require additional capital expenditure and if these acquisitions do not perform according to the expectations, the financial viability of other projects may be called into question.

However, the company aims to provide visibility and security on cash flow and protect the downside by engaging in hedging, at the cost of potential upside, which protects it from an adverse fluctuation in market prices. 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. 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. 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. Through the acquisitive growth strategy undertaken by the group, it has successfully achieved higher production and an increase in midstream revenue. 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 manner. The group has also decided to move towards the main market of the London Stock Exchange, which will expose it to a larger pool of investors and reflects successful operations of the business since its inception.

Conclusion

In the last five years, the company has shown exceptional growth, with both top and bottom line increased significantly and can be attributed to the aggressive policy of the company. Revenue has grown by a CAGR of 241.25% over the last five years. Operating profit reported a CAGR growth of 129.7% over the previous four years, while the corresponding increase in net profit was 114.25%.
Based on the decent growth prospects, and supported by valuation undertaken using the above two methods, we have given a “Speculative Buy” recommendation at the closing price of GBX 110.00 (as on 30 September 2019), with single-digit upside potential, based on 3.02x NTM EV/Sales (approx.) on FY19E sales (approx.) and 7.94x NTM Price/Earnings (approx.) on FY19E earnings per share (approx.).
 
*The “Speculative Buy” recommendation is valid for the current price as covered in the report (as on 01-October-19).
*All forecasted figures and Peer information have been taken from Thomson Reuters.

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