Diamondback Could Be Snaring Sweet Spot In Midland Basin

According to analytical soothsayers, Diamondback Energy Inc.’s (FANG) future varies from slamming with faint praise to the expectation the Midland Basin pure play will continue to dust competitors.

So far in 2015, Diamondback has outperformed its peers in the SIG Oil Exploration & Production Index (EPX) by 32%, said David Kistler, co-head of E&P research, Simmons & Co. International.

Most analysts expect more of the same. Even in a severe downturn, Diamondback has been one of few E&Ps to knock out a sizeable deal, acquiring 11,948 net acres in northwest Howard County, Texas, for nearly $438 million. And it’s possible the company may buy more of the scattered, privately-owned lands in that corner of the county, an analyst said.

Overall, the company’s prudent financial management and smart acquisitions seems a good recipe for gaining ground in the Permian, said Gabriele Sorbara, analyst, Topeka Capital Markets.

Its recent acquisition in northwestern Howard County is part of a growing interest there after it has been largely underappreciated by investors.

Sorbara said the focus for Diamondback remains on execution, reducing per well costs and increasing EURs as it moves into a new corner of Howard County.

Diamondback is a “classic beat and raise story,” he said, suggesting that the company’s guidance underestimates what it believes it can actually produce.

“Based on our analysis of the Wolfcamp and Lower Spraberry results reported to the Texas Railroad Commission and our conversations with managements in the area, we believe northwestern Howard County is situated in a sweet spot,” Sorbara said.

A number of privately-held assets are located in the area and Sorbara said consolidation could be in the making.

“We believe FANG may further build out its position in this sweet spot,” he said.

Robert Du Boff, analyst, Oppenheimer & Co. Inc., is not as sure that the company can continue its rout of other E&Ps. Diamondback faces limited upside because it is already at peak efficiency.

Recently, the company went as far as to say its breakeven prices were below $30 per barrel (bbl) of WTI.

Diamondback was one of the most efficient operators in the Permian prior to the oil price collapse, Du Boff said.

While much of the industry focused on costs, Diamondback already has low capital and operating expenses.

“Diamondback has found itself with very little fat to trim outside of a few short-term spikes due to acquisitions,” Du Boff said.

Nearly all of its recent cost reductions come from service company concessions, “price breaks which could start to reverse as activity in the basin is once again picking up.”

What may hurt the most is that A&D activity continues to be muted and the still young company had flourished in an active market.

Since going public in October 2012, the company’s foundation has been to build a bigger foundation. From 2012-14, Diamondback acquired $1 billion in leaseholds and paid $502 million for mineral rights.

In a two and a half year span, its production has increased 705% to 30.6 thousand barrels of oil equivalent per day (boe/d). Its stock price has risen to $78 from the initial offering price of $17.50.

Kistler said that he expects Diamondback’s production to fall in the second quarter after its Howard County acquisition and the chore of ramping up activity in the second half of 2015. He said earnings per share (EPS) is likely to drop.

But the company’s value will likely see a 15% upside compared to peers such as Approach Resources Inc. (AREX), Concho Resources Inc. (CXO), Laredo Petroleum Inc. (LPI), Parsley Energy Inc. (PE), Pioneer Natural Resources Co. (PXD) and RSP Permian Inc. (RSPP) with less than 5%.

“While FANG has outperformed the EPX by 32% year-to-date, we expect more of the same going forward,” he said. “Due to FANG's excellent and low cost execution, coupled with leading edge cost reductions, the company is able to accelerate activity in a depressed commodity environment while living within cash flow for the balance of the year.”

Contact the author, Darren Barbee, at dbarbee@hartenergy.com.