Diamondback Energy, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Diamondback Energy, Inc. is an independent oil and natural gas company focused on the acquisition, development, exploration and exploitation of unconventional, onshore oil and natural gas reserves in the Permian Basin in West Texas.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Diamondback Energy operates in the volatile oil and gas industry, where their value is heavily influenced by commodity prices, making it difficult to predict long-term profitability with certainty, even while showing resilience in face of the inherent volatility of the industry, it does not display a significant moat.

Business Overview Diamondback Energy operates primarily in the Permian Basin, one of the most prolific oil and gas producing regions in the United States.

  • Revenues: The company’s revenue is derived from the sale of crude oil, natural gas, and natural gas liquids. A high degree of the company’s financial health comes from operations and production and a lot of it is dependent on commodity prices.

As of Q3 2024, oil sales accounted for $2.1 billion, natural gas for $197 million and natural gas liquids for $2.2 billion, while proceeds from derivatives amounted to $0.7 billion.

  • Production: The company has production primarily in the Midland Basin and Delaware Basin. They operate a mix of vertical and horizontal wells with a focus on optimizing production output.

Total production averaged 463 MBOE/d in the third quarter of 2024.

  • Margins: The margins fluctuate with changes in commodity prices, and the company is focused on controlling its production costs to maintain profitability.

In the third quarter, operating expenses were $1.12 per BOE, cash general and administrative expenses were $0.93 per BOE and production and ad valorem taxes and transportation expense of $5.16 per BOE.

  • Competitive Landscape: The oil and gas industry is highly competitive, with numerous companies, both large and small, vying for drilling rights, resources, and market share. The primary players in the Permian Basin include major firms such as ConocoPhillips, Devon Energy, and Pioneer Natural Resources, as well as a large number of smaller independents.

Diamondback’s strength stems from its operational prowess within specific areas of the Permian, its focus on low-cost operations in specific areas, but its profitability can be directly hurt by the volatility in commodity prices, and any company with large cost advantage can quickly expand production.

  • What Makes FANG Different: Diamondback’s focus on maximizing returns over sheer volume growth, which contrasts with many competitors, who prioritize production growth above all else. Additionally, the company has focused on lower-cost and highly efficient well operations and strong financial health.

Their focus in the Midland Basin has also led to a high percentage of their production that is oil instead of natural gas, which has higher prices and margins than natural gas.

Financials Deep Dive

  • Revenues: Diamondback’s revenues are directly correlated with oil and natural gas prices. As of Q3 2024 the company recorded $4.2 billion in total revenues (including derivatives).
  • Net Income: The company reported net income of $931 million in the third quarter of 2024, which is impacted by commodity prices and hedging activities.
  • Margins: Operating margins are greatly influenced by production costs, which they have kept in control as a matter of strategy, along with fluctuating oil and natural gas prices.
  • Cash Flow: The company’s cash flow was substantial, but may vary depending on fluctuations in commodity prices and capital expenditure.

Net cash from operating activities was at 3.4B in Q3 2024.

  • Debt: The company maintains a conservative approach to debt leverage, and they work towards paying it off, while continuing to invest in new projects.

Total long term debt on balance sheet in the latest 10Q is 12.4 Billion dollars.

  • Liquidity: The company has a strong liquidity position, as demonstrated by its cash balances and credit facilities, but is impacted due to volatility in oil prices.
  • Investments & Capital Expenditures: The company makes substantial investments in exploration, well development, and acquisitions and have a history of active acquisition.

The company is planning for $2.4 billion to $2.8 billion in CapEx in 2024 with drilling, infrastructure, facilities, and acquisitions.

  • Dividends and Share Repurchases: Diamondback returns cash to shareholders through a variable dividend strategy that aims to distribute 50% of free cash flow as dividends, while it also buys back the company’s own shares from time to time, and are often done to offset dilution from stock-based compensation.

Q3 2024 share repurchase was 59 million and dividends were 493 million.

Note that debt and share repurchases can substantially change the financial picture, particularly in terms of per-share earnings calculations.

  • Recent Performance: Diamondback had a strong operating performance in Q3, but its profits and cash flow have varied with commodity price fluctuations. Their stock value has been volatile.

Because of the cyclicality of oil and gas prices, the financial results of FANG can vary significantly each quarter.

  • Moat Rating: 2 / 5
    • While the company has some scale advantages (as a very large player in the area) and low-cost production techniques in specific areas, and proven operational prowess which drives some profits, they operate in a commodity business where pricing power is limited. Any competitive advantage can quickly be eroded. Therefore, no clear moat exists.
    • The presence of some specialized operations in key basins does offer a small element of differentiation, but overall it does not equate to a competitive advantage as it does not provide a sustained pricing edge, or any kind of barrier to entry and competition.
  • Understandability: 2 / 5
    • While the core business is the relatively straightforward operation of extracting and selling oil, natural gas and natural gas liquids, the specific details are complex and depend on lots of different factors, including commodity prices and geological data. Further, accounting for all the derivative positions and taxes is pretty complex as well. Analyzing commodity related companies is especially tricky and need understanding of complicated financial instruments.
  • Balance Sheet Health: 4 / 5
    • Diamondback’s balance sheet is considered to be in a relatively good state, having been managed with a focus on keeping debt levels down. The company has demonstrated strong cash flow generation capability, a solid debt-equity ratio, and consistent profitability.

Legitimate Risks to the Moat and Business Resilience:

  • Commodity Price Volatility: This is the biggest threat to the business, as the company’s profitability is heavily dependent on oil and natural gas prices. Any substantial decline in prices can impact their bottom line.
  • Operational Risks: Production volumes can be affected by operational issues like equipment malfunction, or other operational problems. These are inherent in the business and any unexpected issue can affect production and profits.
  • Regulatory risks: Changes in regulations and environmental policies, or environmental liability, could have implications on operations.
  • Competition: The Permian Basin is a competitive region, and new entrants or the expansion of the current competitors can put pressure on Diamondback’s performance, mainly in terms of pricing pressure.
  • Global Supply and Demand: Global supply and demand can be unpredictable and affect commodity prices, as there is often a mismatch between demand and supply, causing prices to fall.
  • Inflation and Economic Factors: Inflation increases costs of production and services, while macroeconomic conditions can impact demand and consumer spending, leading to an overall volatile environment for the company.
  • Acquisition Risks: As a very active acquirer, Diamondback takes the risk that those acquisitions will not add as much value as planned. Furthermore, integrating different companies may have operational hurdles.

Recent Concerns/Controversies/Problems:

  • Permian Basin M&A: The company is very active in the Permian basin and recently has closed some large acquisitions, including Endeavor Energy Resources LP, all of which can potentially lead to integration problems, overpaying for acquisitions, or changing the financial characteristics of the company.
  • Rising Costs: There is an emphasis being placed by management to focus on further cost control and efficiency measures. The market is keenly watching these to see how the company reacts to the increasing cost of production.
  • Uncertainty from Global Events: As with all oil and gas companies, global factors can influence the overall demand of oil and natural gas, leading to changes in profitability that are unpredictable and volatile.
  • Debt Obligations: The company, despite reducing its debt, still has a large debt pile on its balance sheet. A lot of it comes in form of senior notes, which may affect the company’s ability to take more debt or to maintain the existing debt.
  • Share Repurchases: The company’s heavy involvement in share repurchases to combat dilution from stock-based compensations may not be seen favorably by all the investors.

Note that for long term investors who seek sustainable profits based on a business’s intrinsic value (without focusing too much on share price appreciation), these share repurchases may be seen negatively because the cash can be more profitably used in internal or external investment activities.