Qualitative analysis is looking at more than just the numbers, it’s looking at the operating environment, profitability, management and other things that can’t be put into a discounted cash flow model. It gives a deep look at the business and is always good when making an investment thesis in combination with a quantitative (looking at the numbers) approach.
Diamondback Energy 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. The Permian has a favourable operating environment, mature infrastructure and long reserve life, we shall take a look at those after I quickly present why this particular company sparked my initial interest.
What initially sparked my interest in this company was the EV/EBITDA (NTM) of just 6.2x (EV/EBITDA is a metric that provides a better picture of a companies financial performance than just P/E) and its operating cashflows have been rising quickly over the years, see figure 1.
Figure 1: operating cash flows of FANG over the years, from Koyfin
The operational side
When looking at a producer like FANG it’s important to assess costs, the resulting margins, reserves and how the competition fares.
|Company||Production cost (/boe)|
|Pioneer Natural Resources||$7.7|
Table 1: production costs, from Seekingalpha article which took it from investor presentations and own calculations
We can see that Diamondback is not the lowest cost producer realised pricing is also different for most here as Diamondback operates in the Permian where infrastructure supports good price realisation for example Continental Resources doesn’t have this advantage. See table 1.
Diamondback mostly extracts oil which also has additional gas. The estimated proved reserves were approximately 58% oil, 22% natural gas liquids and 20% natural gas, see figure 2.
Figure 2: reserves by commodity, from Q1 2021 presentation
How long do these reserves last? well see table 2
Table 2: Reserves from seeking alpha article
Combining this knowledge with the growth portrayed in figure 3 we can see that low reserves aren’t the problem here, more so a possibility for stranded assets.
Figure 3: total reserve growth. From Q1 2021 presentation
With such a low production cost in relation to the general market (especially offshore producers), the resulting high margins even with hedging and volatility oil prices shouldn’t surprise anyone. See figure 4.
Figure 4: margins, taken from Koyfin
We see that Gross, EBITDA, and EBIT margins look very promising, the writedowns do provide significant volatility in margins but taking those out we get a very nice picture.
Diamondback has several important subsidiaries which must be noted:
Viper Energy Partners LP (58% ownership):
Owns mineral interests in the Permian and Eagle Ford Shale.
Rattler Midstream Partners LP (72% ownership):
Ownership, operation, development and acquisition of midstream infrastructure assets in the Midland and Delaware Basins of the Permian.
So by buying FANG you also get exposure to more assets than just those of Diamondback.
Diamondback recently acquired Guidon Operating LLC and QEP Resources adding an aggregate of over 80,000 net acres to the asset base in the Permian Basin.
Divesting Williston Basin assets (95,000 acres) acquired in the merger with QEP and non-core Permian Basin assets (8,300 acres) for total consideration of $832 million. The proceeds will be used to reduce debt.
Maturities seem fairly under control with most coming between 2023 and 2027, see figure 5.
Figure 5: Diamondback maturity profile, Q1 2021 presentation
Free Cash Flow
Figure 6: FCF guidance, Q1 2021 presentation
Based on guidance with some assumptions ($2.5/Mcf for gas which is out of their control, the rest of the assumptions is within their control) we can see (from figure 6) that even at $60 WTI cash flow remains strong.
The author of the SeekingAlpha article noted that hedging played a very large role in 2021 and must be accounted for in FCF calculations. See figure 7. I would be cautious in accounting for those as it does limit upside and downside.
Figure 7: Oil hedges, Q1 2021 presentation
I did a fairly simple DCF calculation based on Aswath Damodaran’s teachings (go watch that youtube course, even if it’s in the background he really makes you look at things differently). I used a 30% CAGR revenue growth (so 23.08% each year the first 5 years and then declining to 1.61%), this is fairly conservative as revenue growth has been all over the place but mostly way higher than that. See figure 8. The Year of convergence was the fifth year and the industries sales to capital ratio of 0.46 was used as well.
Figure 8: Revenue growth YoY, from Koyfin
If you remember the nice margins from figure 4 a conservative 30% was used in the calculation, could it be higher yes just as CAGR could be higher or lower, I’ll show the different possibilities and their results later.
Figure 9: inputs DCF
The above are the inputs (see figure 9), the output is the following (see figure 10):
Figure 10: DCF results
The results from this DCF provide a very bright view from an investors standpoint, but CAGR might be lower just as margins might be lower or higher. In figure 11 A simple table of the results is given from different input values for CAGR and op margin.
Figure 11: effects of CAGR and op margin on DCF outcome
A more conservative approach would also look at shorter-term and look at FCF yield now, which in figure 6 was noted. See figure 12 where those numbers are put into perspective and the unhedged FCF from the SeekingAlpha article was also taken into account.
Figure 12: FCF yield (mCap based)
Taking into consideration the fluctuations in wti I would put a fair value of about $96-107 with wti at $63 which is my base scenario. With wti around 55-60 I would expect around $67-75 as a fair value and from $60-65 wti my estimation would be $124-138 per share of FANG. All of these are estimations and this stock certainly is a play on the oil price staying above $60 wti as I would estimate it being overvalued at current prices if wti drops below that. I hope this was an interesting read and provided some food for thought, I’m interested in what your opinion on this is!
Diamondback investor relations, 2020 annual report and Q1 2021 report.