Does the 13%+ Diversified Energy dividend yield mean I should buy?

With dividends approaching 14% (yes, 14%!), Energy Diversification (LSE: DEC) continues to amaze me. Often high yields are an alarm bell that dividends may be cut. On the other hand, gas producers have had record annual dividend increases in recent years. As a long-term investor, are Diversified Energy’s dividend prospects attractive enough for me to invest in?

Recently increased

Last year, Diversified again raised its payout, by 2.9%. if it continues at that level for the rest of the company’s financial year, it will be the company’s fourth consecutive year of dividend growth.

However, past performance is not always a guide to future performance. Indeed, over the long term, I have some concerns about whether Diversified can support payouts at current levels, let alone a larger dividend fund.

The company is losing money

In its latest annual accounts, the company reported a one-year loss of $325 million after tax. It made a loss at the operating level ($467m, equal to 46% of revenue). But the pre-tax loss was even bigger, more than half a billion dollars. In other words, the numbers look less bad after tax than before. That’s always a red flag for me. In my view, healthy businesses should see their tax lines worsen, not increase their bottom line.

The previous year saw the same pattern although on a smaller scale: losses at the operating level, pre-tax profit, and post-tax profit.

In the interim stage of this year, the company remains at a loss in terms of operational and net income.

Operating cash flow is positive

Instead, the company pays dividends using cash. Profit and loss are accounting concepts and may differ from cash flow in a company.

Diversified aims to pay a dividend of about 40% of its free cash flow. At last year’s operating level, operating free cash flow was $320m. The $130m dividend expense is actually about 40% of this.

But operating free cash flow, which is different from total free cash flow. The company saw $626m of net cash outflow on investing activities. Cash flow was boosted by $317 million of net cash from financing activities, but included $1.7bn of loan proceeds.

My movement

Diversified has a novel and potentially profitable model. It has bought tens of thousands of small, old gas wells. Buying a well costs a lot of money, as seen in the company’s investment cash flow.

Raising money has helped the company expand rapidly – hence the debt. This month the company also raised around £135m of net new cash by issuing shares. That can help grow the fund, but at the cost of diluting shareholders. Further dilution is an ongoing risk.

Revenues and profits can rise – or fall – as energy prices move. The cost of capping the estate of old wells can be high. In addition, Diversified is cash flow positive at the operating level, but has significant non-operating costs such as acquisition costs. Interest costs alone last year were $42m.

Juggling that cash flow seems like a delicate balancing act to me, especially if energy prices fall. Next dividend payment on Diversified Energy Ltd. But I see the risk of cutting winter. I will not invest.