First Berlin – Diversified Gas & Oil PLC Research Update (01/09/2020)

First Berlin Equity Research has published a research update on Diversified Gas & Oil PLC (ISIN: GB00BYX7JT74). Analyst Simon Scholes reiterated his BUY rating and increased the price target from GBp 130.00 to GBp 150.00.

Following the H1 results we have reworked our dividend discount valuation of the DGOC share to reflect both a higher Q2 dividend of USD0.0375 (FBe: USD0.035) than we had forecast, and rising gas futures prices since our end-June initiating coverage study. Based on a futures curve which slopes upward for the remainder of this decade and DGOC's existing hedge portfolio, we expect the natural gas prices realised by the company over the next five years (after the impact of cash-settled derivatives) to be stable in the range USD2.34/mcf to USD2.57/mcf. This compares with our 2020 forecast of USD2.30/mcf. Fully loaded H1/20 cash costs (after operating expenses, capex, well retirement costs and cash interest) were USD1.36/mcf. This indicates a free cashflow margin on sales of at least 42%-47% (economies of scale are likely to push unit costs lower as the company expands) during the next five years. DGOC should thus have plenty of firepower to keep making the regular acquisitions through which it has secured over 95% of its current production since early 2017. DGOC's target is that not less than ca. 40% of adjusted free cashflow, defined as adjusted EBITDA (hedged) less maintenance capex, interest expense and well retirement costs, should be paid out as dividends. On our forecasts the payout ratio on this basis at the current dividend level will be 43% this year and 44% in 2021, and so we think the current dividend is sustainable. The combination of a dividend yield above 10% and strong and stable cash generation reinforces our view that the share is substantially undervalued. Moreover, the current market cap. warrants DGOC's inclusion in the FTSE 250 Index. New index members will be announced after the market close on 2 September with effect from 21 September. Our recommendation is Buy with a price target of GBP1.50 (previously: GBP1.30).