Diamondback Energy: 7x earnings is an energy diamond in the rough

After falling short of Wall Street earnings estimates for the first and second quarters, Diamondback Energy, Inc. NASDAQ: FANG got back on track in Q3 — in a big way.

The oil and gas producer clobbered consensus expectations by delivering third-quarter earnings per share (EPS) of $5.49. Analysts were braced for $5.01. The outperformance was consistent with what the market had grown accustomed to after the company beat EPS estimates in every quarter but one from 2020 to 2022. 

Diamondback also exceeded third-quarter revenue projections. It generated revenue of $2.3 billion, driven by strong production. Operating primarily in the Permian Basin area of West Texas and New Mexico, it produced an average of 452,848 barrels of oil equivalent per day (BOE/d), a 16% increase over last year. Most of the production growth came from Diamondback’s crude oil assets, which accounted for approximately 60% of overall production. Natural gas liquid volumes increased more modestly.

As has been the case with other industry players, Diamondback couldn’t get its strong top line growth to flow through to the bottom line. That’s because realized sales prices were significantly lower compared to the third quarter of 2022. Diamondback’s average realized oil price was $81.57 per barrel (down 9%), while its average realized natural gas price plunged 75% to $1.62.    

The results were a reminder of how U.S. oil and gas producers are at the mercy of commodity prices and the market dynamics that drive them. They also highlighted the importance of running a tight ship when it comes to expenses — which is something Diamondback excels in. Third-quarter cash operating costs declined 12% year-over-year to $10.51 per barrel, one of the lowest in the industry.

Diamondback’s positioning as a low-cost producer in the lucrative Permian Basin separates it from the pack. The financial results lead to further distinguishing the company as an attractive long-term investment. 

Regardless of the energy price environment, Diamondback has historically managed to generate good cash flow and reward shareholders with dividends and buybacks. The current 10% correction from the October 2023 record peak may be something value investors want to ‘drill’ into further. 

What is Diamondback Energy’s growth outlook?

In conjunction with the Q3 update, management raised its full-year production forecast to 447,000 BOE/d. While it is good news that drilling activity is poised to stay healthy, energy prices unfortunately remain less than healthy. Since the fourth quarter began, WTI crude prices have been on a steady decline. 

On Monday, oil slipped to $73.50 amid ongoing uncertainty around OPEC+ output cuts and a weak demand outlook. News that Brazil plans to join OPEC+ in 2024 and ramp its daily production to 3.8 million barrels, along with a higher U.S. rig count, have kept pressure on oil — and have outweighed the geopolitical risks tied to fighting in Gaza.

Falling oil means Diamondback is likely in for another down quarter in Q4, which has caused its stock to dip back into the $150’s. Shareholders need not panic. First, volatility is the nature of the beast when it comes to oil stocks. Second, lower profits won’t impact Diamondback’s ability to create shareholder value.

Is Diamondback Energy stock undervalued?

Diamondback’s value proposition begins with passing along excess cash to shareholders. The board of directors recently approved a quarterly dividend of $0.84 per share in addition to a $2.53 per share special dividend. On a forward-looking basis, this equates to $5.89 in total cash payouts and a 3.8% forward dividend yield. Going beyond the numbers, it shows that management is committed to consistently rewarding shareholders — even in a tough operating environment. 

The company also bought back $56 million of its own stock during the third quarter at an average price of $136.59 (about $17.00 below where the stock is currently trading). Repurchasing shares during downturns has historically provided downside support for the stock and helped restore investor confidence.

Based on Wall Street’s projection for 2024 EPS, Diamondback has a price-to-earnings (P/E) ratio of 7x. Among 15 domestic large cap oil producers, this ranks fifth lowest. Considering Diamondback’s top-notch assets and below-average cost profile, the stock arguably deserves a premium valuation.  

Undervalued and shareholder-friendly. These are the main reasons why 18 of 20 sell-side analysts are bullish on Diamondback. Much larger peers like Conocco Phillips get much of the headlines — but at these prices, Diamondback should get more love from the market.