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Diversified Gas & Oil: Risk-Reward Analysis

Summary

  • Diversified Gas & Oil is deeply undervalued at this point in time, as shown by my risk-reward analysis.
  • Going forward, I anticipate a number of catalysts to drive a re-rating, on top of production and EBITDA growth.
  • Enormous upside and largely mitigated risks make this stock attractive for both income and capital appreciation investors.
  • Looking for a helping hand in the market? Members of The Natural Resources Hub get exclusive ideas and guidance to navigate any climate. Learn More »
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“Some companies are built to drill, and some to operate. Diversified is built to operate very efficiently." - An investor

In a previous article, I stated Diversified Gas & Oil Plc (DGOC.LSE)(DGOCF) - DGOC henceforth - actually performed extremely well in terms of

Diversified Gas & Oil is just one of the many hidden-gem ideas pitched by Laurentian Research. Benefit from his industry experience by joining The Natural Resources Hub, a hidden-gem Marketplace service that consistently delivers high rates of return at low risk for members. 

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This article was written by

Laurentian Research profile picture
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As a natural resources industry expert with years of successful investing experience, I conduct in-depth research to generate alpha-rich, low-risk ideas for members of The Natural Resources Hub (TNRH). I focus on identifying high-quality deep values in the natural resources sector and undervalued wide-moat businesses. This investment approach has proven to be extremely rewarding over the years.

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Disclosure: Besides myself, TNRH is fortunate enough to have multiple other contributing authors who post articles for and share their views with our thriving community. These authors include Silver Coast Research, among others. I'd like to emphasize that the articles contributed by these authors are the product of their respective independent research and analysis.

Analyst’s Disclosure: I am/we are long DGOCF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (33)

arb-inv profile picture
Trying to follow the trail of US tax resident issues. I recently opened a trade in my Interactive Brokers account. Have yet to receive any dividends but will do at next distribution. As an individual investor holding this in a taxable account can anyone explain if I should file any forms ahead of tax season to avoid any withholdings? I want to avoid the kind of shenanigans I found myself in a few years back with MLPs where the additional tax prep was often more than the income and it was a huge complexity.
b
@arb-inv Diversified goes exdividend on Sept 3rd, payable on Sept 24th.
SilverMiner profile picture
Why did DGOC list on a London exchange?
Laurentian Research profile picture
@SilverMiner
At the time, they get a better valuation in London.
arb-inv profile picture
@Laurentian Research It sounded to me like it was more availability of capital than valuation as at the time they entered AIM they were objectively too small for the US markets.
jonjung profile picture
Diversified Gas and Oil is a very interesting company and I really like their business strategy. What I don't understand is the hedging strategy and results. The cashflow statement (p 45 of current powerpoint) shows a loss on fair value of unsettled financial instruments of $239 Million and if you look at the P&L statement (p 43) they show a loss of $94 million on these derivatives. I don't understand why they have such losses when Southwestern and AR showed gains. Can someone give me some help on these complex strategies and the results for DGOC? Thanks
ofirm profile picture
@jonjung I suspect that when they buy properties they put hedges to
the point of servicing the loan for a few years. this way they get credit
in order to do transactions. they probably assume that rising market
would increase the value of the asset by much more than what they
lose on the hedges. on the way down, hedges usually buy you time.
It is a conservative and smart strategy.
Laurentian Research profile picture
@ofirm Thanks for helping @jonjung out.

Jon, you may also find this webinar helpful (www.youtube.com/...). I went through that webinar numerous times for its rich information.

Edison had a few research reports on DGOC. See if you can find them by googling.
jonjung profile picture
Good article on Diversified. A US listing on major exchange will help reduce the valuation gap. I own DGOCF shares in both my IRA and taxable accounts and the recent dividend was reduced by 30% tax in both my Fidelity accounts. This is true both for shares bought on the London exchange and for those in my IRA that were bought in the OTC market. I will claim those foreign taxes paid on my tax return. The midstream assets are also a plus for Diversified as well as the new partnership with Oaktree. Do you know how to value the lease acres that Diversified owns? Besides DPD, what is the value of the non-producing acres and will the partnership with Oaktree give the company money to drill wells on these acres? Or are these fields fully developed with no future potential? Thanks for your work on this little known company.
Laurentian Research profile picture
@jonjung
Thanks for sharing your experience wrt to tax withholding.

There are various techniques to value shale acreage, which may not work for DGOC. DGOC got 5% of reserves that are not PDP, which it develops opportunistically; but little is known about these uncontiguous undeveloped reserves, other than relying on DGOC's NPV-10 estimates. As for assets to be bought with Oaktree money, we'll know better how to peg an intrinsic value on them once we see what they are.

GLTAL!
SilverMiner profile picture
Why are hedges reported in Mcf when Henry Hub prices are reported in MMbtu?
Laurentian Research profile picture
@SilverMiner
Good question. The management explained in the footnote on p. 26 of this document: d1io3yog0oux5.cloudfront.net/...
George Fisher profile picture
Nice review and in tandem with your previous article. I have a starter position as I like the cast-off business model, much like Steven Ferris $APA of decades ago. However, please explain the divy withholding tax as I think the US and Britain have a tax treaty whereby US investors are exempt from divy tax. Headquarters in Alabama and home exchange in LSE. Are they not domiciled in the UK as well?
Laurentian Research profile picture
@George Fisher
Thank you for commenting.

Please read the comments in the posane3 thread.
George Fisher profile picture
@Laurentian Research
I think it is odd that you recommends a stock which pays a dividend and which you considered an income stock but yet will not comment on the important topic of tax treatment of your income recommendation.

Here is what I found on their website:
"Pursuant to Section 7874 of The Internal Revenue Code, Diversified is treated as a U.S. corporation for all purposes under the Code. Therefore, dividends from the Company may be subject to US withholding taxes, depending on the country of residence of the shareholder, and whether the country has an income tax treaty with the United States. The statutory rate of withholding under the Code is 30 percent, which may be reduced by an applicable treaty.

For non-US Shareholders who are individuals that have not previously completed the appropriate US Withholding Tax Form, Form W-8BEN (or W-8ECI in some cases) relating to US withholding tax for non-US investors should be completed. For non-US Shareholders who are corporate entities, Form W-8BEN-E (or, if applicable, Form W-8IMY or Form W-8ECI) relating to US withholding tax for non-US investors should be completed. In some cases, Form W-8ECI may be applicable to individual Shareholders that have other U.S. taxable income and file a U.S. income tax return.

For Shareholders who complete and return the US withholding tax form relevant to them, the rate of US withholding tax will be adjusted to a rate of between 0% and 30% depending on the elections provided by the Shareholder in the Form W-8 and in accordance with the withholding rate under the applicable double income tax treaty (for example, 15% under the US-UK treaty).

A brief summary of the purpose of each of the Forms W-8 is provided below with links to the form and its instructions:"

ir.dgoc.com/...

As a new shareholder, I expect to watch carefully the first quarterly distribution to see how my broker classifies the distribution. As a US resident, if I get a divy tax withholding, the next call will be to my broker.
Laurentian Research profile picture
@George Fisher
I pointed you to my previous comment, which explains my view. Please undertand personally I don't view tax matters are a DYI-able task, and as I said, I often consult my accountant who is a tax expert.
p
Thanks for the analysis. I hold a token position in an IRA. Alas, nearly half of the dividend is eaten away by foreign tax, and trading costs are high. Hopefully it will get listed on a major U.S. exchange soon. I don't know how that will affect the taxation issue, though. A little digging on that issue would be very helpful to your followers.
k
@posane3 That makes no sense, as although UK listed, the company is US based. The only tax on dividend should be similar as for US stocks, as long as you have submitted the tax treaty form. I am in the opposite position, actually. I hold DGOC in my supposedly tax free ISA account but still have to pay a 15% tax on dividend as it is a US company, down from 30% had I not completed the tax treaty form. Summarising, speak to your broker. What you are saying does not sound right.
Laurentian Research profile picture
@posane3
Good point though I have been of the view that readers should combine fundamental analysis, including what I presented here, with idiosyncratic transactional design (which stock exchange to buy it, how many shares to buy, what's the tax consequences, how to hedge the position, etc.), which really varies from a reader to another and from time to time. Personally, I often consult my accountant who is a tax expert.
p
@Laurentian Research - This might be a Fidelity issue. At the time of the dividend, they "reversed" $2.30 of it, with no explanation. At the end of the year there was no mention of any "foreign tax paid". This was a traditional IRA. They also charged $40 for a 100-share purchase. These amounts are not worth spending an hour on the telephone to resolve, but I am not inclined to invest a lot in this one until I get it resolved.
ofirm profile picture
Thanks for the idea. the management sounds like additional dd is warranted
here for me.
Laurentian Research profile picture
@ofirm
Thanks a lot for your comment. That's a good point. Please share your take after your DD on the management is done.

I also talked about the management here:
seekingalpha.com/...
seekingalpha.com/...
seekingalpha.com/...
Laurentian Research profile picture
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