Following on from strong HY results, Diversified Gas and Oil produced an even better Q3 update at the end of October. When management presented at the latest Yellowstone Advisory webinar on 3rd November, they were justifiably pleased with recent performance and confident in future opportunities. A recording of the webinar is available here.
CEO Rusty Hutson Jr. started the webinar by running through some of the operating highlights of the quarter. Daily production increased 7% to 107MBOEPD on the back of another strong performance from the legacy gas assets. This is the ninth straight quarter where the company has delivered very low declines from legacy assets. In the Q&A section, Rusty talked about the work they are doing to put wells back into production, improving the maintenance of wells and fixing pipelines to improve production and that they still have a long way to go on this front. So low declines are expected to continue for a while. This helped generate adjusted EBITDA of $75m, an increase of 10% and an EBITDA margin of 52% - described by Rusty as being outstanding. They maintain their position as a low-cost producer with production costs at $1.18/Mcfe in line with the previous quarter ($1.17). The company also said they would try and maintain these costs going forward.
Some time was spent on the company hedging policy and the outlook for gas prices. One of the points reiterated a couple of times in response to questions from the audience was that the company would always forgo potential upside from higher prices by protecting against any downside shocks and ensuring more predictable cash flows by a conservative approach to hedging production. Henry Hub prices were as low as $1.83 this year but prices have recovered, and the forward curve is now above $3.00. At $2.75 gas price for DGOC, which is where they are currently hedged, would generate 57% EBITDA margins on a full year basis. Natural gas prices for 2021 continue to improve and the company has increased its hedging position for 2021 to 80% of production at a floor price of $2.66 MMBTU giving improved confidence in future cash flows. There is a feeling that natural gas macro conditions have improved this year and continue to look attractive.
The recent acquisitions of Carbon and EQT have been successfully integrated into the operating structure of DGOC and these wells are performing in line with expectations. Overall capex to EBITDA was 8% in the current year down from 12% the previous year as most well expense is captured in operating expenditure.
Rare in the sector, DGOC has increased the quarterly dividend to USc4, an increase of 7% on the Q2 dividend and up 14.3% on last year. This is completely consistent with the pay-out policy and as they bring acquisitions online and generate strong free cash flow, 40% will be paid out to shareholders. We were reminded that management hold 7% of the equity and the dividend is important to them too.
Company talked about the potential for further acquisitions. US$221m of liquidity was available at 30 Sep 2020. The balance sheet is in good shape with net debt of $730m, equivalent to 2.2x ND/EBITDA. Over 70% of the debt structure amortises so that the company pays back principle as well as interest which the company believes is a really good discipline for the business to follow.
The company discussed the recent partnership deal with Oaktree Capital and there was also a couple of questions about how the partnership worked. Oaktree has great experience in the E&P space and has committed to invest up to $1bn in assets alongside DGOC. Investment will be on a 50:50 basis but the economic interest will be 52.5:47.5 in DGOC’s favour. Investment opportunities below $250m DGOC will finance on their own and opportunities above this will be shown to Oaktree. Once Oaktree has made a 10% IRR a further 15% of their share of the economic interest will be returned to DGCO so that in 4/5 years’ time DGOC will own 59.625% of the asset and Oaktree the balance. There continue to be a lot of acquisition opportunities that they investigate but they are being very selective currently. M&A needs to add value, provide synergies, be accretive to earnings and dividends and offer upside opportunities.
With the webinar on election day it was natural to touch on the impact of a democratic president and a change in the senate the biggest risk was perceived to be drilling on federal land – something that DGOC does not do.
Having listed in 2017 DGOC moved to a premium list and into the All-Share and FTSE250 indices in September.
Overall, it was another good update from DGOC and management are demonstrating a consistent track record of delivery.
A recording of the webinar can be found on the Yellowstone Advisory YouTube channel or by clicking here.
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