Despite the FTSE 250 enjoying a solid rally so far this year, not all of its constituents have been so fortunate. Ithaca Energy‘s (LSE:ITH) a prime example of this, with shares tumbling almost 30% since the start of the year, pushing the dividend yield to just shy of 16%.
Usually, seeing a payout level this high’s a giant red flag. Yet last month, management announced and paid yet another dividend, suggesting shareholder payouts are here to stay. And with the price-to-earnings ratio of just 6.2, these energy shares look dirt cheap.
Is this a trap too good to be true? Or are investors looking at a rare and terrific income opportunity? Let’s explore.
Digging into the details
As businesses go, Ithaca has a habit of falling under the radar of most energy investors. After all, it’s a tiny enterprise compared to titans like BP and Shell. Yet following the recent acquisition of Eni’s oil & gas assets, Ithaca’s become a major producer of fossil fuels in the North Sea. In fact, the company’s currently on track to produce 150,000 barrels a day by the early 2030s.
Apart from boosting revenue and earnings, the transformational deal’s also expected to deliver numerous cost savings as well as improve the firm’s credit score. Needless to say, this is all rather positive. And it would explain why management has committed to pay out $500m of dividends in 2024 and 2025.
That all suggests today’s 16% dividend yield’s here to stay. So why aren’t investors snapping up this seemingly no-brainer bargain?
Risk vs reward
From a production standpoint, Ithaca’s future looks promising. But it comes paired with quite a bit of corporate uncertainty. For one thing, the company’s currently subject to a massive windfall tax that’s harming profitability. But more crucially, to execute the Eni deal, management’s likely going to have to issue a lot of new shares. In other words, equity dilution could be hiding just around the corner.
Therefore, while $500m of dividends might be getting paid, the actual dividend per share and yield could be significantly lower than current levels in the near future. It’s difficult to determine exactly where things will stand. And this uncertainty appears to be what’s dragging the FTSE 250 stock into the gutter right now.
Time to buy?
Buying when everyone else is selling can be a lucrative investment strategy. And the same might be true for buying Ithaca Energy shares in 2024. However, that very much depends on whether management can successfully deliver on all its acquisition targets.
When handling deals of this magnitude, a lot of unforeseen complications can emerge. Suppose the integration process is disrupted, or the Eni assets don’t meet performance expectations. In that case, management may inadvertently compromise the balance sheet, sending the share price even lower.
Personally, I’m not interested in adding this sort of uncertainty to my portfolio right now. So I’m turning my attention to other promising FTSE 250 stocks with lower risk profiles.
This post was originally published on Motley Fool
