Why Diamondback Has Outperformed SandRidge and Kodiak

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After its debut as a public company in October 2012, Diamondback Energy's (NASDAQ: FANG  ) stock has gone up more than 200% in the past year alone. An independent energy producer with a market capitalization of about $3 billion, the company currently sells for more than 82 times trailing earnings. What is Diamondback doing right, and how does it compare to two other similar-sized oil and gas companies?

Focused on the Permian Basin
Diamondback generates income by finding and producing oil and natural gas from established plays in the Permian Basin of Texas. Specifically, it operates in the Wolfberry Trend, a geological formation that encompasses a variety of oil plays, including Wolfcamp, Spraberry, and Atoka.

This focus on one oil play resembles the strategy of SandRidge Energy (NYSE: SD  ) and Kodiak Oil & Gas (NYSE: KOG  ) . As the chart below illustrates, while all three companies have similar market capitalizations and generally focus on developing one oil play, Diamondback's stock has conspicuously, ahem, outperformed the others. How is Diamondback doing it?

FANG Chart

Diamondback Energy data by YCharts

Rapid production growth and more
According to Diamondback's latest investor presentation, oil production was relatively flat in 2012. Things changed in 2013 when Diamondback began using horizontal drilling and hydraulic fracturing. Oil and gas production rose 149% year over year for 2013, and the company projects a 112% increase in production for 2014. Roughly three-quarters of this production is oil; the rest is natural gas. The company claims this is the highest oil-to-gas ratio of its peers. Further, its growth in proven reserves is also heavily skewed toward oil.

On top of all this, the company's operating expenses declined over the past three years. Specifically, in 2012, the cost of production was $27.83 per barrel of oil equivalent (BOE). At the end of 2013, costs were $15.59 per BOE. For 2014, Diamondback projects $14.98 per BOE. Declines in lease-operating costs and general and administrative expenses were the main factors in the overall decline in expenses.

As a result, earnings went from a loss in 2012 to a profit of $1.29 per share (diluted) for 2013. If Diamondback delivers on its projected production for 2014, those earnings should go significantly higher.

So what about the others?
SandRidge pursues a similar business strategy in that it produces oil from one location, namely the Mississippian Lime in Oklahoma and Kansas. This lime is well known for holding oil, but its geology is such that traditional vertical wells made production uneconomical. SandRidge uses horizontal drilling and extensive surveying of the Mississippian formation to tap into these oil reserves. SandRidge also has an extensive wastewater (aka "produced water") disposal and electricity infrastructure in place to further reduce its costs.

SandRidge recently sold its interests in producing Gulf of Mexico assets to further its investment in the Mississippian Lime. Some might question the wisdom of selling productive assets when Mississippian production is so variable. That SandRidge took a loss on the transaction adds to the headscratching.

That said, in its latest investor presentation, SandRidge projected significant increases in production in oil, natural gas, and natural gas liquids. Unlike Diamondback, roughly half of SandRidge's production is natural gas. Also unlike Diamondback, SandRidge has not reported growing earnings. One wonders what this Thursday's earnings announcement portends.

Kodiak drills for oil primarily in the Bakken oil play. It also works the Vermillion natural gas play in Colorado, but this is clearly secondary to Bakken oil. Bakken oil production soared over the past few years, and Kodiak is right in the thick of it. According to its latest investor presentation, Kodiak produced 601 BOE a day in 2009. In 2013, production was 29,200 BOE a day, and 2014 forecasts are for 42,000 to 44,000 BOE a day.

Like SandRidge, Kodiak will announce its earnings this Thursday. Unlike SandRidge, insiders sold off more than 1 million shares in December. Was this tax-related selling or something else? Perhaps we will find out by the end of the week. 

One perplexing aspect of Kodiak is the rise in production and revenue don't necessarily match earnings. As the chart below shows, revenue of late climbed admirably and earnings declined. This is in the face of declining drilling expenses and increased production. Hopefully Kodiak will report rising earnings and revenue this Thursday.

KOG EPS Diluted (Quarterly) Chart

Kodiak EPS diluted (quarterly) data by YCharts

Final Foolish thoughts
So, why is Diamondback doing so well relative to SandRidge or Kodiak? Simply stated, Diamondback grows its production and its earnings follow. Further, Diamondback's Permian Basin play is safer and more predictable than SandRidge's Mississippian Lime. SandRidge's earnings trend is also disappointing.

Kodiak picked a good place to drill for oil judging by its production record. However, that growing production doesn't translate into consistently growing earnings. Add the mystery of insider selling of late, and it's not surprising investors aren't embracing Kodiak like they do Diamondback.

Does Diamondback deserve its rich valuation? If its production growth continues and its earnings keep up, yes, Diamondback should reward investors well. Be advised, however, that an earnings disappointment could clobber the stock.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 26, 2014, at 2:22 PM, sensible1 wrote:

    I believe the article is somewhat misleading in that it is my understanding that horizontal drilling is much more environmentally damaging and poses far greater risk than vertical. Therefore, the short term growth may very well be a harbinger of bad things to come...jmo

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Robert Zimmerman

Middle aged man investing since his college days. Writing for Motley Fool, in part to learn more about companies I might not know about, in part to encourage folks to be more active in their financial affairs.

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