Diamondback Energy: More Upside Potential Ahead

Shares of Diamondback Energy, Inc. (

FANG, Financial) are higher by 133% year-to-date as the company has seen a sharp recovery in its stock price on the back of global energy demand rebounding from a very difficult 2020.

This return for the stock is also well ahead of the 41% gain in the iShares Global Energy ETF (

IXC, Financial) this year, so it has outpaced its peer group by a wide margin.

Even with a gain such as this, Diamondback Energy still trades at a reasonable forward multiple and is well below its intrinsic value based on certain estimates, suggesting that shares still have more room to the upside.

Let’s look closer at the company to see why I find Diamondback Energy to be an undervalued and appealing investment option even at the current price.

Earnings highlights

Diamondback Energy reported third-quarter earnings results on Nov. 1, 2021. Revenue grew 165% year-over-year to $1.9 billion, beating Wall Street analysts’ estimates by $430 million. Adjusted earnings per share of $2.94 far exceeded adjusted earnings per share of 62 cents in the prior-year quarter and was 15 cents better than expected.

The company’s average production totaled 239.8 million barrels of oil per day, with Permian Basin production at 223 million barrels of oil per day. Energy equivalent totaled 404.3 million barrels per day for the company and 374.3 million barrels per day for the Permian Basin.

The third-quarter average total realized oil price was up 76% to $68.27 per barrel. The company saw its average total realized natural gas price more than triple to $3.34 per one thousand cubic feet (or Mcf) while average realized natural gas liquids price improved two-and-a-half times to $31.70 per barrel.

Free cash flow totaled $740 million. During the quarter, the company repurchased 268,000 shares at an average price of $82, which now looks like a good use of capital considering where shares trade at today. The company also announced a share repurchase authorization of $2 billion, or nearly 10% of its current market capitalization.

The company’s balance sheet is in good shape. Diamondback Energy ended the quarter with total assets of $22.6 billion, current assets of $1.5 billion and cash and equivalents of $457 million against total liabilities of $21.2 billion and current liabilities of $2 billion. Total debt is nearly $7 billion, but just $20 million of this is due within the next year.

Diamondback Energy now expects production of 222 million to 223 million barrels of oil per day and 370 million to 372 million barrels of oil equivalent per day for the full year. This is up slightly from prior guidance. Leadership said that production levels will remain relatively constant from the current year even with persistent higher energy prices.

According to analysts, Diamondback Energy expect that the company will earn $11.02 per share in 2021. For 2022, those same analysts expect business to be even more profitable as estimates for the year average $17.35.

Takeaways

Diamondback Energy’s third-quarter numbers were even better than pre-pandemic results as both revenue and adjusted earnings per share nearly doubled from the third quarter of 2019. Those results themselves were also improvements from the prior-year period.

Diamondback Energy is a relatively young company, having conducted its initial public offering in 2012. In that time, the company has gone from a medium-sized oil and gas company to one of the largest names in the Permian Basin.

Diamondback Energy’s focus on the Permian Basin has helped the company grow over the years. The company has an estimated 10,000 undrilled locations in the Permian, which could provide for many years of oil production. Diamondback Energy has a low cost of energy production of around $30 per barrel. This means that the company’s operations have been profitable even when demand for energy products has been weak, as was the case last year.

Besides its core business, the company has also used acquisitions as a way to grow. For example, Diamondback Energy spent $2.2 billion to purchase QEP Resources, which has significant midstream infrastructure near the Permian Basin. This acquisition was completed on March 3, 2021.

While energy prices are considerably higher today than they were a year ago, the company’s production for 2021 is expected to be flat from this year. This should help support higher prices, as long as other companies don’t drastically increase their production, which would allow Diamondback Energy to grow its free cash flow and reduce its debt.

The expected influx of capital should allow for the company to conduct share repurchases, which investors can take as a bullish sign from management. With the ability to retire nearly one out of every 10 shares on higher energy prices, Diamondback Energy should be able to show impressive earnings per share growth, lending support to the share price even after more than doubling over the last 11 months.

Dividend and valuation analysis

Despite its youth, Diamondback Energy has been aggressive in its dividend growth as shareholders have seen their annual dividends triple since the company began paying distributions in mid-2018. Business has been so good so far in 2021 that Diamondback Energy has raised its dividend three times this year, this time 11.1% from the prior quarter’s payment. The company distributed a 50 cent per share dividend on Nov. 18, which marks a 33% increase from the same period a year ago.

The company distributed a total of $1.75 in dividends per share during 2020. Using the new annualized dividend of $2.00, Diamondback Energy has a forward yield of 1.8%. This compares favorably to the 1.2% yield that the company has averaged since it began paying a dividend.

Using Tuesday’s closing price of $110.19 and analysts’ estimates for the year, Diamondback Energy has a forward price-earnings ratio of 10. For context, this is well below the average multiple of 22 times earnings since 2012, according to Value Line. The multiple shrinks even further when using estimates for next year, down to just 6.4 times earnings.

The GuruFocus Value chart also finds that shares are trading below their intrinsic value:

The stock has a GF Value of $126.52, giving Diamondback Energy a price-to-GF-Value ratio of 0.87. Reaching the GF Value would result in a nearly 15% increase in the share price. This would be on top of the return that has occurred year-to-date. Shares are rated as a modestly undervalued by GuruFocus.

Final thoughts

Diamondback Energy, like all energy companies, isn’t without risk. The stock is more or less a pure trade on the price of oil, but he company does have an enviable portfolio of assets and a low price of oil at which it can be profitable. The dividend yield is on the low side, but dividend growth has been generous and the projected payout ratio appears to be extremely healthy. The stock trades at a low valuation relative to its own history and appears to be trading at mid-teens percentage below its GF Value. For these reasons, I believe the stock is undervalued.