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Morningstar | Diamondback Announces Substantial Share Repurchase Program. See Updated Analyst Note from 08 May 2019

Diamondback delivered production of 263 mboe/d in the first quarter, which includes the first full contribution from the assets acquired with Energen during the fourth quarter of 2018. This compares with our forecast of 258 mboe/d. Realized prices were slightly lower overall than they were in the fourth quarter due to steep declines in both crude and natural gas benchmarks, masking strong improvements in basis differentials for both commodities (reflecting Diamondback’s effective marketing strategy as well as generally stronger Permian Basin fundamentals). And further improvement is anticipated on the oil side--management is now guiding for average unhedged oil realizations within 90%-95% of West Texas Intermediate for the remainder of 2019. But while prices weakened unit costs improved slightly, and these improvements should be sustainable (partly due to the announced divestiture of the unwanted portion of Energen’s Permian portfolio, primarily in the high-cost Central Basin Platform area). Overall, the firm’s financial results were mixed, with adjusted EBITDA and adjusted earnings per share coming in at $651 million and $1.39, respectively (consensus estimates were $679 million and $1.35).

The improvement in production costs was not captured in our prior forecasts. However, the impact on our fair value estimate is partially offset by reducing our growth estimates in 2020 and beyond. In the release Diamondback announced a robust $2 billion stock repurchase program, which will be funded by the surplus cash flows it can generate when WTI crude exceeds $50/bbl. As a result, it is less likely that the company will ramp activity with further rigs as we were previously anticipating (we now expect the company to run 20 rigs from 2020, instead of 24). Nevertheless, the net impact on our valuation is positive, and our updated fair value estimate is $127 per share.

The budget for 2019 was unchanged, while production guidance was lowered slightly to account for the 6.5 thousand barrels of oil equivalent per day to be sold with the noncore sale mentioned above (though that transaction will raise over $322 million, or roughly $50,000 per flowing boe, when it closes in the second quarter). That translates to about 26% annual production growth, while living within cash flows. Even without adding rigs, we expect several further years of double-digit production growth and our model supports management’s claim that it can generate $750 million in free cash in 2020 at $55/bbl WTI (we model $790 million, to be precise).