Diamondback Keeping Lid on Inflation for 2023 and Maintaining 75%-Plus Free Cash Returns

Diamondback’s FANG fourth-quarter production was in line with previous guidance, and its financial results were slightly better than consensus estimates from FactSet. The firm plowed just 32% of the free cash it generated in the period back into drilling, and like most upstream firms, the firm will be investing frugally in 2023 as well. On an acquisition-adjusted basis, management is targeting 2% year-over-year volume growth, with a 14% hike in capital spending that is mostly driven by service cost inflation. We were already assuming 10% well cost inflation, so the uptick wasn’t a shock, and 14% is still much less than what other upstream firms have reported. And the increase was offset by other factors, including the surprise sale of noncore assets across the portfolio that will raise over $600 million with negligible impact on our net asset value estimates. As a result, we have raised our fair value to $126 per share from $116.

Management was also able to achieve its commitment to return 75% of free cash flow to shareholders for the second consecutive quarter, funneling back a total of $861 million across several channels. And it will maintain this payout in 2023 as well, utilizing a variable dividend as well as repurchases to augment the fixed dividend, which was raised again by 7% and is up 33% over the last year. It was encouraging to see that returns were weighted toward cash (63%) rather than buybacks, as we think too many E&Ps are risking value destruction in a commodity upcycle by buying back stock hand over fist. That said, the buyback authorization still has $2.4 billion left to be fulfilled, and we still see shares as slightly overvalued.