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Summary

  • FANG's Q2 2014 production was up 32% from Q1 2014 and 171% from Q2 2013 at 17.8 Mboe/d.
  • On July 18, 2014, FANG announced the acquisition of 13,136 net acres in the Permian Basin with production of 2.2 Mboe/d and 5.2 MM of proved reserves.
  • FANG spun off VNOM in Q2 2014. It retained ownership of 92% of the common units and all of the IDRs.
  • FANG is working to cut costs and improve drilling and completion techniques for further profits.

Diamondback Energy Inc. (NASDAQ:FANG) is an independent oil and natural gas E&P company. It primarily acquires and develops unconventional, long-life, onshore oil and natural gas reserves in the Permian Basin in West Texas. Some of the major formations are the Clearfork, the Spraberry, the Wolfcamp, the Cline, the Strawn and Atoka formations. These formations are also known as the Wolfberry trend. FANG had about 72,000 net acres in the Permian as of May 9, 2014. If you include the July 18, 2014 Purchase and Sale Agreement acreage, FANG has about 85,000 net acres in the Permian. This total includes the 12,687 net acres delivered to VNOM at the end of its IPO.

The most recent 13,136 net acres added on July 18, 2014 are mostly in Midland and Glasscock Counties. FANG bought them for $538 million. They have production of 2.2 Mboepd and 5.2 MMboe of proved reserves. There are 396 gross (256 net) identified potential drilling locations. Other companies in the areas of these acres are seeing strong production results for new wells. The map below shows their location in the Permian.

In addition to this production and reserves add, FANG's Q2 2014 production increased 32% to 17.8 Mboe/d from Q1 2014 and 171% from Q2 2013. With the 2.2 Mboepd added to that, the production would be 20.0 Mboepd. Of course, this is without considering the Viper Energy partners LP (NASDAQ:VNOM) IPO, which is technically a subsidiary of FANG. It got 14,804 gross acres (12,687 net acres) in the Permian Basin in West Texas and proved oil and gas reserves of 10,270 Mboe (48% PDP and about 70% oil) from FANG. Net production was approximately 1,919 Boe/d in December 2013. 50% of the assets are operated by FANG. VNOM gets an average 21.4% royalty interest from all production from this acreage. From September 18, 2013 through December 31, 2013 that royalty interest amounted to $15.0 million. The following table contains the updated production guidance for FY2014.

(click to enlarge)

This is increased guidance from the 15.0-16.0 Mboe/d guidance of March 2014. This appears to be another case of under promising, so you can outperform. With the new acreage acquired, it would seem that FANG is a shoo-in to meet these goals; and it should surpass them. It should help that VNOM recently acquired an additional 3,447 net acres in the Midland and Delaware Basins for $90 million in cash. The company believes it to be an accretive acquisition. However, details are scant at this time. With this deal VNOM now has 16,134 net acres of leaseholdings. VNOM is 92% owned by FANG, which also owns all of VNOM's IDRs.

Among the operating details, it stands out that the lease operating expenses for Q2 2013 were $6.47 per Boe, which was down from $9.16 in the year ago quarter. The six-month cost cut has been from $10.09 per Boe in the year ago 1H to $6.48 per Boe in 1H 2014. This is great management. Unfortunately, interest expense in Q2 2014 was $4.77 per Boe compared to $0.89 per Boe in the year ago quarter. Considering the expansion in leaseholdings in the last year, that is acceptable. Hopefully, management can keep lease operating expenses low in order to compensate for that.

The money FANG took in the Viper Energy IPO should help to decrease FANG's debt level. As of June 30, 2014, VNOM had distributed $137.5 million to Diamondback Energy. This put a dent in FANG's debt; and VNOM contributions should help more in the future. There is also the possibility of a new public offering, which might completely eliminate all of FANG's debts. Yahoo Finance lists FANG's debt at $496 million. This is a very reasonable amount of debt for a company with a market cap of $4.44B and an enterprise value of $4.90B.

Another positive about FANG is that it received a credit upgrade from Moody's on July 22, 2014 for its Corporate Family Rating of B3 to B2. Moody's raised its Probability of Default Rating to B2-PDR from B3-PDR. Moody's raised its senior unsecured note rating to B3 from Caa1. Moody's changed the rating outlook from stable to positive. This is a positive for FANG's credit; and it also indicates that FANG's chances of success are higher in the eyes of Moody's. This should reassure investors.

FANG is also trying out different development techniques. For instance, it recently tried 120 acre spacing (660' inter-lateral spacing) versus 160 acre spacing (880' inter-lateral spacing) with no degradation in performance. FANG is also moving to more pad drilling. The company is estimating drilling and completion savings of $1.25 million to $1.5 million for a three well pad. This doesn't sound like it will change the results such as EURs (Expected Ultimate Recovery) though. Hence, the table below gives the metrics FANG is finding.

(click to enlarge)

The above look good, and they will no doubt sustain FANG over the long term. In fact, FANG has been averaging cash margins 24% to 47% higher than those of its peers over the last 1.5 years. For instance, FANG's cash margin for Q4 2013 was $64.41, while its peers average cash margin was $47.20. This gives FANG a big advantage when it comes to potential profits.

Other developers such as Continental Resources (NYSE:CLR), EOG Resources (NYSE:EOG) and Oasis Petroleum (NYSE:OAS) are using new completion techniques such as slickwater fracking. They are seeing roughly 35% improvements in 24 hour IP rates. This usually translates roughly into 35% improvement in EUR's. I see no reason that FANG cannot copy these techniques in future quarters. That might mean a 35% greater yield of Boes per well; and that would be a huge boon to FANG. The chart below shows some of CLR's test results in the Bakken.

In this light, FANG is a buy on the current dip. It recently fell from $91.41 per share to $75.86 (about a -17% fall). It closed August 16, 2014 at $78.45, so there is still a lot of room for a rally to the upside, especially since the Ukraine problems are back in the news.

Russia is the biggest oil producer in the world with production of about 10.5 million bpd. If a significant portion of that is taken offline for political or other reasons, there could be a large disruption in the oil markets. This would likely send oil prices skyrocketing.

Is there a fundamental reason other than the Ukraine and other "positive for oil" geopolitical events to buy FANG now? Yes, it is a growth stock that has fallen dramatically (-17%). It has an average analysts' five year EPS growth per annum forecast of 60%. It is forecast to grow EPS by 122.30% in FY2014 and 39.80% in FY2015. With an FPE of only 20.86, it is very much a buy on this dip. If that were not enough there are technological achievements that FANG is just starting to implement. I mentioned the 3-well pads that FANG will drill in 2014. These are slated to save $1.25 - $1.50 million per three well set. This is a technique that FANG is just starting to implement. It will likely expand this program to go to 6 to 8 well pads in time. FANG only started pad drilling in late 2013. This will save even more money.

FANG has not said it is implementing slickwater and/or other newer fracking techniques. Given its lagging position in pad drilling, I would expect it to do this relatively soon too. According to CLR's tests in the Bakken this will allow FANG to recover roughly 35% more oil from each well. This will mean more profits, more production, and automatically higher levels of reserves. Essentially, investors could just multiply the results table for the various zones above by 1.35x to get the likely near future results for the same types of wells using slickwater fracking.

Without these results, FANG increased production by 171% year over year from Q2 2014. Analysts have not added all of the above new benefits into FANG's numbers. That means FANG should perform even better than they anticipate. That means beats and raises. Even in a tough economic environment that makes FANG a buy on a big dip, especially with its current FPE and growth metrics.

The two-year chart of FANG provides some technical direction for this trade.

(click to enlarge)

The slow stochastic sub chart shows that FANG is oversold. The main chart shows that FANG is in a long-term uptrend. FANG's stock price has broken down recently to touch its 100-day SMA. That has over the past two years been a great buying opportunity for the stock. I would expect it will be again this time, as long as you are taking the long-term view. In the shorter term, it is much harder to say where the overall market will go (and FANG will follow). One solution to this problem is for investors to average in.

NOTE: Some of the fundamental fiscal data above is from Yahoo Finance.

Good Luck Trading.

Source: Multiple Catalysts Make Oversold Diamondback Energy Attractive