This FTSE 250 energy firm currently generates a 19% annual yield that could make big passive income over time, but how risky is it?

The FTSE 250’s Ithaca Energy (LSE: ITH) frequently appears in my stock screener as a potential passive income stock buy. Passive income is money made with minimal effort by the investor, as with dividends paid by shares.

Currently, the North Sea energy giant has a dividend yield of 19%! This compares to the current average FTSE 250 yield of 3.4%.

That said, it is important to note that a stock’s yield changes as its share price and annual dividend alter.

In Ithaca’s case, consensus analysts’ forecasts are that its dividend will fall to 20.2p in 2025, 20.5p in 2026, and 17.3p in 2027.

Based on the £1.36 share price at the time of writing, these would give yields of 14.7%, 15.1%, and 12.7%.

So, should I finally buy it?

Key selection criteria

It also ticks my second box that requires a significant undervaluation in the share price. This reduces the chance of me making a loss if I sell it.

The next thing I want is a significant undervaluation present in the share price. This reduces the chance of my making a loss if I sell it.

A discounted cash flow valuation shows the oil firm is is 60% undervalued at its current £1.36 price. So the fair value of the stock is £3.40, is 60% undervalued at its current £1.36 price. So the fair value of the stock is £3.40, although market forces could move it lower or higher.

And the final element I expect to see is strong earnings growth. It is this that drives a stock’s dividend and price higher over the long term.

However, analysts forecast its earnings will grow by just 0.2% a year to the end of 2027.

Earnings growth

Ithaca’s 2024 results showed earnings before interest, taxes, depreciation, amortisation and exploration expenses declining 18.4% year on year to $1.405bn (£1.06bn). This was due to lower average oil and gas prices compared to 2023 and to lower production volumes.

In turn, its profit dropped 48% over the year to $153.3m. This was exacerbated by $351m paid in taxes, the majority of which was the Energy Profits Levy.

However, Ithaca expects its 2025 operating cost to stay in the low $20 per barrel of oil equivalent (boe) area. And it forecasts its oil and gas production will rise to a maximum 115,000 boe per day (kboe/d) from 105.5 kboe/d.

This is expected to come from its October $975.8m acquisition of Italian oil and gas giant Eni’s UK assets. A risk here for the firm is a failure to manage the transition of these assets optimally, which could push costs higher.

Will I buy the stock?

Overall, I would buy the stock today if I were even 10 years younger, just for the yield alone. It also looks very undervalued to me, so I might make a good profit on that too.

However, I am at the later stage of my investment cycle now, aged over 50. This means I avoid any stocks I think have a higher-than-average risk attached to them. And I think this is one of those.

The post This FTSE 250 energy firm currently generates a 19% annual yield that could make big passive income over time, but how risky is it? appeared first on The Motley Fool UK.

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Simon Watkins has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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