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Stock Strategist

Don't Be Scared of Diamondback and Viper

Here are two undervalued ideas to ride out the challenging times in energy.

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The coronavirus outbreak has created a huge dent in near-term oil demand and triggered a meltdown for commodity prices. The market appears to be extrapolating the current oil environment to infinity, and that doesn’t make any sense: Shale still accounts for over 10% of the global supply stack, and unless prices rebound to encourage drilling, the painful glut will eventually become a shortage. As a result, oil stocks are cheap. Our top upstream pick, Diamondback Energy (FANG), hasn’t traded at this level since shortly after its 2012 initial public offering, and its publicly traded mineral rights subsidiary, Viper Energy Partners (VNOM), has reached an all-time low.

Both are pure plays on some of the best U.S. shale acreage. Diamondback checks many of the boxes for investors, with a strong balance sheet, an underappreciated narrow economic moat, and an increasingly prominent focus on free cash flow and environmental, social, and governance concerns. Viper presents an attractive way to piggyback on Diamondback’s attractive Permian acreage. Diamondback is the operator on over 50% of Viper’s acreage and offers exposure to a mineral rights market that could double in size with potential for further upside. Viper is the industry leader in consolidating the royalties market, having spent $2.4 billion in acquiring rights in the past few years.

Stephen Ellis does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.