2023-06-20 07:45:33 ET
Summary
- Diamondback Energy's management repurchased more than 2 million shares during the banking crisis.
- That purchase likely repurchased shares issued for the Lario acquisition at a discount to the assumed deal value.
- The share purchase action decreased the variable cash available to distribute to shareholders to $.03 per share.
- Oil production per share will grow 11% despite management statements to please the market about not growing production.
- Both the base dividend and the variable dividend are likely to rapidly trend higher as the company grows.
Diamondback Energy ( FANG ) management took advantage of the banking crisis to repurchase 2.53 million shares for roughly $131 per share. If one goes to the Seeking Alpha website, then one can see that the price of the common shares was getting close to $160 at the time of the announcement of an acquisition using shares (Lario acquisition) in November 2022. So, the chance to repurchase most of the shares issued during that acquisition at a discount to just about any reasonable price used in assessing the acquisition value is going to increase the accretive nature of that acquisition permanently.
Management also disclosed some one-time items that affected cash flow. Nonetheless, cash flow from operating activities before changes in noncash working capital accounts was actually nearly $200 million higher than the year before because the year before benefited from a big favorable Accounts Receivable balance adjustment.
As the operating situation returns to normal and cash flow items lack the one-time items of the first quarter, the second quarter should have more cash available for distribution to shareholders. The second quarter will also benefit from the full quarter inclusion of the Lario acquisition (which has an increased accretive characteristic thanks to the opportunistic share repurchase). There may be some organic growth as well from strong well performance.
Despite some shareholder concerns about the variable dividend for the quarter, management seems poised to continue to raise the dividend through the pricing volatility that is long a part of this industry. This is one of the few managements that found a way to grow production per share while honoring market demands for a variable dividend. Shareholders should expect more accretive acquisitions in the future.
Diamondback Energy Overall Review Of 2023 Guidance And Progress (Diamondback Energy May 2023, Earnings Conference Call Slides)
The oil production share is likely to prove to be above average. Any organic growth from stronger than expected well production will be "icing on the cake". The strategy of growing production in any way, shape, or form allows for the variable distribution to trend higher over time and the base distribution to grow as well.
For investors that can handle a variable income amount, this is a growth and income story with an attractive rate of return throughout the business cycle.
Management also expects to benefit from the acquisitions by spending less capital than was the case for the prior owner. Some of this savings is because management will maintain production whereas the prior owner grew production. Other savings will come from operational optimization by management.
Diamondback Energy History Of Returning Cash To Shareholders (Diamondback Energy May 2023, Corporate Presentation)
Diamondback Energy management issued 5.86 million shares for the Firebird acquisition (which was announced in October). Management then issued another 4.18 million shares in the Lario acquisition (which was announced in November). Clearly, the share repurchase program has recovered those Lario shares. Depending upon how one wants to analyze the situation one could say that previously purchased shares at considerably lower prices were used for the purchase when the stock price was considerably higher.
Management even purchased the equivalent of the shares back for the most part after the mergers to have the stock to be used yet again for another accretive acquisition.
Diamondback Energy Key Debt Considerations (Diamondback Energy May 2023, Earnings Conference Call Slides)
The debt due is clearly favorable. Management has an additional chance to repurchase debt at a discount because interest rates have been rising. That would benefit shareholders as well.
Despite the pledge to use most of the cash flow to return value to shareholders, management sold noncore assets as promised to speed the reduction of debt. This company has long been conservative about debt ratios. As a result, this is one of the few companies that I follow that has achieved an investment grade rating in the industry.
Management will likely continue to repay debt from a combination of cash flow and noncore asset sales. The usual industrywide goal is to have conservative debt ratios at considerably lower commodity price levels. That would imply at least another $1 billion of debt repayments in the future.
Diamondback Energy Well Performance And General Operational Update (Diamondback Energy May 2023, Corporate Presentation)
There has been some worries about less "prime" acreage to develop in the future. What the above slide shows is that there are potential improvements through technology advances that keep costs down. Even if advances do not come to keep that overall curve smooth, they do seem to come in such a way that more and more of the oil in place is commercially recoverable.
Investors should expect technology advances to continue probably well past most of our lifetimes (and then some). This country has a lot of oil and gas yet to be recovered. Had technology not advanced in the past we would have run out of recoverable reserves long ago.
So, the worries about us running out of oil and gas appear to be misplaced. Diamondback management clearly made some progress in improving production. As long as management keeps cost low to remain a low cost leader, then investors have little worry about the downside of the business cycle for this industry. Companies like Diamondback with low costs generally thrive throughout the business cycle. Clearly though, the company makes more money when commodity prices are stronger as they are now.
The Future
Diamondback now has a decent production growth rate mainly through acquisitions. But management can easily switch back to organic growth if market demands change.
The dividend is also growing rapidly (both the base dividend and the variable part). The combination of dividend growth and growth through acquisitions is likely to lead to a long-term growth rate in the upper teens. That is a pretty good return for a large company with an investment grade rating.
Even from the current price, the stock is likely to outperform the industry for a very long time. At some point, Diamondback may become an acquisition candidate. Most buyers prefer well run companies with few problems. This is one of those companies.
Plus, good management often proves to be quite a long-term bargain for acquirers even if the price paid is not a bargain. Management is often the most important asset not on the balance sheet. This company has some of the best management in the industry.
For further details see:
Diamondback Energy: Management Takes Advantage Of The Banking Crisis