Separate the hype from reality
To make good calls, an investor must set the hype aside and focus on the fundamentals. Diamondback Energy Inc (NASDAQ:FANG) owns 51,700 net acres in the Permian Basin in West Texas, drilling both low-cost vertical wells and high-cost horizontal wells targeting the Wolfberry play. It produces almost 4,600 barrels of oil equivalent per day (boepd) (85% oil and liquids) currently, and its proven reserves as of Dec. 31, 2012 were 40.2 million boe (86% oil and liquids).
As of Dec. 31, 2012, the company had $26 million in cash, no outstanding long-term debt and $135 million in un-drawn borrowing capacity. As of Feb. 25, the company had drawn $30 million under its revolving credit facility. After all, the enterprise value (EV) is ~$1 billion currently, that translates into $217,000/boepd and $24.88/boe of proven reserves.
These staggering multiples can’t send the shorts running for the hills. Actually, these multiples are quite inexplicable for a junior producer when several other intermediate and major oil-weighted players carry much lower valuations.
For instance, Whiting Petroleum Corp (NYSE:WLL) is a heavily oil-weighted producer with sizable operations in the Permian basin. It produced 86,055 boepd (86% oil and liquids) in Q4 2012 and has 378.8 million boe proved reserves (December 2012). With an EV at $7.5 billion, Whiting Petroleum Corp (NYSE:WLL) trades at 87,000 boepd and $19.80/boe of proved reserves.
Moreover, Whiting Petroleum Corp (NYSE:WLL) guides for production growth of 12% to 16% for 2013. On top of that, Whiting has land diversification and holds significant acreage in three oil-prone areas (Rockies, Permian and Mid-Continent), while Diamondback Energy Inc (NASDAQ:FANG) is a one-basin play with relatively small acreage.
This is a major drawback that has to concern all of Diamondback’s potential buyers along with its current shareholders. After all, why should one prefer Diamondback over Whiting?
Looking ahead
Diamondback Energy Inc (NASDAQ:FANG) guides for production of 7,200 to 7,500 boepd and capex at $270 million to $300 million for 2013. It expects to have drilling results from five horizontal Wolfcamp wells by May, and plans to spend 67% of 2013 capex on expensive horizontal wells that cost $7.5 million to $8.5 million each. Diamondback also guides that it will fund its 2013 capex from existing cash, cash flows and debt.
Magellan Midstream Partners plays a major role in Diamondback’s cash flow in 2013 because its projects will provide Diamondback access to Louisiana Light Sweet (LLS) pricing. This access translates to the equivalent of $11/barrel price improvement relative to current levels.
To be more specific, Magellan will finish a reversal of the Longhorn pipeline from Crane, Texas to Houston and begin moving 75,000 boepd by Q2 2013.
Additionally, Magellan is proceeding with the BridgeTex pipeline, which will transport almost 300,000 boepd of Permian Basin crude from Colorado City, CO. to Houston. It is expected to begin service mid- 2014.
Through this access to LLS pricing, Diamondback Energy Inc (NASDAQ:FANG) estimates a $15 million to $20 million annual cash flow enhancement, based on projected production, which is expected to commence H2 2013. Nevertheless, it’s clear that the existing cash together with the cash flow fall short of the total 2013 capex by approximately $120-$130 million. This shortage will be covered either by long-term debt or the issuance of new equity.
Even if the best production case scenario occurs and the company avoids the operational hiccups in 2013, Diamondback will have an estimated $130 million long-term debt by year end.
Assuming the stock doesn’t correct from the current levels, and the company hits its production targets, the EV will be $1.1 billion in December 2013. This translates into $150,000 per flowing barrel, which is woefully high despite the fact that this production is oil-weighted (85% oil and liquids). With such valuation, Diamondback Energy Inc (NASDAQ:FANG) will not be attractive as an acquisition target either. Why?
Check out SandRidge Energy Inc. (NYSE:SD), which struck a deal recently to sell its Permian Basin properties to privately-held oil and gas company Sheridan Production Partners for $2.6 billion. With the proceeds, SandRidge Energy Inc. (NYSE:SD) will reduce its worrisome debt load and fund development of its core Mississippian play.
SandRidge Energy Inc. (NYSE:SD) was producing 24,500 boepd from these oil-weighted assets (82% oil and liquids) that were purchased at $106,000 per flowing barrel, while the basin average is about $100,000 per flowing barrel. The transaction metrics were obviously rich, although they were not enough to calm SandRidge’s shareholders, who have been calling for a restructuring of the company’s board and for the CEO to resign.
Foolish round up
The investors who keep track of my articles, remember my bearish calls about several overvalued stocks, such as Forest Oil Corporation (NYSE:FST), Quicksilver Resources Inc (NYSE:KWK), W&T Offshore. For instance, I discouraged all to buy Forest Oil and W&T Offshore at $7 and $15.50, respectively, a few weeks ago. These two stocks hover at $5 and $13, respectively, today.
This time, I am warning all about Diamondback Energy Inc (NASDAQ:FANG) and its meaty metrics. To me, it is a good short-candidate at current levels. Those who are optimistic about Diamondback must reevaluate their position. I believe that the market will recognize the gross mismatch between valuation and fundamentals, adjusting the company’s valuation sooner or later.
The article This Energy Play Is Priced Like the Rarest Diamond of the Permian Basin originally appeared on Fool.com and is written by Nathan Kirykos.
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