EUR 850.00 For Business Accounts Only

Morningstar | Recent Diamondback Sell-off Widens Discount to FVE: Now Nearly 30% Undervalued. See Updated Analyst Note from 07 Nov 2018

Diamondback’s third-quarter financial results were in line with consensus estimates, with EBITDA and adjusted earnings per share coming in at $382 million and $1.67, respectively. Production for the period was 123 mboe/d (45% higher year over year). Full-year guidance was increased by about 2% at the midpoint, although a portion of that upside stems from an additional bolt-on acquisition that closed Oct. 31. Diamondback paid $312.5 million for 3,646 net acres near the core of its Midland position (which equates to $33,000 per acre, assuming $55,000 per flowing boe). Capital spending is now expected to come in above prior guidance as well, mainly due to the accelerated build-out of midstream assets.

On the conference call management predicted one to two further quarters with challenging basis differentials due to temporary pipeline congestion (we expect a discount of at least $10/bbl against WTI). It also acknowledged inflationary pressures that come with higher oil prices on the conference call, and highlighted headwinds such as steel tariffs (which drive up prices for tubular goods). However, it expects to offset the negative impact through further efficiency gains, combined with higher utilization of locally sourced sand for fracking and better pressure pumping rates. After taking a more conservative stance on realized prices and well costs we have lowered our fair value estimate to $148 per share from $158.

But that’s still roughly 30% higher than the current price. We believe the market still isn’t giving the firm enough credit for its best in class operating metrics, robust growth outlook, and formidable asset portfolio. It makes little sense that the high-growth industry cost leader is trading at 4.1 times consensus EBITDA for 2020, when the segment average is 4.3 times. Investors are therefore ignoring Diamondback’s rapid growth potential or not recognizing the cost advantage associated with its top-tier Permian acreage.

In fact, the only thing holding us back from an even more positive rating is our bearish stance on long-term oil prices. Our midcycle forecast is unchanged at $55/bbl for WTI, still slightly below the long end of the futures strip (which implies $58/bbl for 2022). The justification in “Oil Prices Are Unsustainably High, Stretching Energy Valuations” is still valid, even though the recent sell-off in energy stocks means many of the bearish conclusions no longer apply. Nevertheless, if we were to adopt consensus' forecast of $61/bbl for long-term WTI, then holding all else equal our Diamondback fair value would be $175 per share.