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Buy locked-in value at Diversified Gas & Oil

It may only just have debuted on Aim, but we think the investment case in this small-scale US gas producer stacks up.
February 16, 2017

We often take a 'wait-and-see' approach to new floats, particularly with natural resources stocks with unproven track records listing on the junior market. In tipping US-based Diversified Gas & Oil (DGOC), which raised $50m (£39.7m) when it joined Aim earlier this month, we are therefore breaking with tradition. We're doing so because, like early-stage investors GLG Partners and Henderson Global Investors, we feel this onshore gas and oil producer's unique operating model means it ticks many boxes: low political risk, low exploration risk, a low-cost profile, good cash generation, room for growth and a fat dividend yield. Despite this, the shares trade at a big discount to broker Mirabaud Securities' risked net asset value (NAV) of 101p a share. And while this valuation is based on gas prices recovering to $3.50mcf from 2018 and beyond, even at today's $2.93, NAV estimates stand at about 70p.

IC TIP: Buy at 58p
Tip style
Income
Risk rating
High
Timescale
Long Term
Bull points
  • Cheap production
  • Steep discount to NAV
  • Prospective dividend
  • Successful fundraising
Bear points
  • Reliance on cheap acquisitions
  • No stock market track record

Over 90 per cent of the company's output is gas, sourced from 7,500 low-volume wells DGO owns and operates in the Appalachian Basin in the northern US. Many of these were acquired from larger conventional oil companies focused on bigger individual positions in shale basins. And while the company has been operating since 2001, it has only in the last few years started to fully benefit from a huge opportunity to buy older conventional assets for next to nothing from shale-hungry US drillers.

At present, production sits at just 4,700 barrels of oil equivalent (mmboe) per day at an average cost of just $9.53 per barrel, although DGO has a total of 27.9mmboe proven reserves, much of them boasting very low decline rates and long lives.

Growing that asset base is predicated on acquiring more wells valued between one and three times annual cash flows, and now that the company has paid down its bonds and debts through its IPO, it should have ready access to funds with which to build its portfolio. Sellers are prepared to let assets go at such low prices in order to secure a reliable operator like DGO that will keep the fields producing, as this is necessary to protect the sellers' retained rights to tap the lower-lying shale gas at a later date. If prices rise significantly in the coming years, and DGO decides to explore for oil on its own, management can be encouraged by a 150 well drilling track record without a single dry hole.

DIVERSIFIED GAS & OIL (DGOC)

ORD PRICE:58pMARKET VALUE:£61.2m
TOUCH:57-59p12-MONTH HIGH:68pLOW: 55p
FORWARD DIVIDEND YIELD:6%FORWARD PE RATIO:12
NET ASSET VALUE:27¢NET CASH:$7m*

Year to 31 DecTurnover ($m)Pre-tax profit ($m)Earnings per share (¢)Dividend per share (¢)
2014¹7.4-0.2-nil
2015¹6.3-0.4-nil
2016¹ ²18.536.2-5.0nil
2017²27.20.63.04.1
2018²30.89.06.04.4
% change+13+1,400+100+7

Normal market size: 3,000

Market makers: 5

Beta: none

£1=$1.26

*Mirabaud Securities forecasts, EPS adjusted figures