On July 1, Diamondback Energy (NASDAQ:FANG) CEO Travis D. Stice executed a transaction to sell 75,000 of his shares in the company. This reduced Stice's holdings to just 14,705 shares -- an 84% decrease from his previous position. Additionally, the largest hedge fund shareholder in Diamondback Energy, Wexford Capital, sold 1 million shares of the company two weeks ago after having steadily reduced its position by about 6.5 million shares over the course of a year. Columbus Circle Investors, the second-largest hedge fund shareholder, cut its holdings by 9%, and Citadel Investment Group sold 44% of its shares.
The company announced a secondary common stock offering in late June, with Wexford Capital and Gulfport Energy Corporation selling the most shares. Such moves are not uncommon when IPO lock-up periods end, but investors must ask why these institutional shareholders want to reduce their holdings at this time, and why the company's own CEO reduced his holdings so drastically. What is all this selling really about?
Diamondback Energy has not been hit with any particularly terrible news or developments. In fact, the company has performed extremely well and has been rewarded by the investing public, as evidenced by its soaring stock price. The company has steadily grown revenue and gross profit over the quarters. Since Q2 2013, both metrics have taken off.
Perhaps its stunning success played a role in the decisions of institutional investors and the CEO to sell -- they may have perceived the stock as becoming overvalued and expensive relative to its peers, and/or were attempting to time the market and pull back before a price decrease. These concerns have merit, and there are two things that deserve careful consideration.
At the end of 2012, Diamondback Energy had just $193,000 of long-term debt -- essentially nothing for a company that had, at the time, over $600 million in assets, $75 million in revenue, and $59 million in gross profit.
At the end of 2013, the company had a whopping $460 million of long-term debt. The total has increased to $587 million as of Q1 2014.
As the graph above illustrates, debt has exploded in the past year. Diamondback Energy currently carries a long-term debt to total assets ratio of 0.3, indicating that the company has $0.30 of debt for every $1.00 of assets.
Being that Diamondback Energy is an oil and natural gas E&P company focused on the Permian Basin, it is best compared to other companies with a similar profile. One such company is Concho Resources (NYSE:CXO), which focuses its operations on the Permian Basin. Another company, LINN Energy (NASDAQ:LINE), operates in the central and western United States, but considers the Permian to be one of its core areas.
By way of comparison, Concho Resources reported long-term debt of $3.67 billion and total assets worth $9.98 billion as of Q1 2014, giving it a long-term debt to total assets ratio of 0.37. LINN Energy carries a long-term debt to total assets ratio of 0.56, having reported $9.26 billion in debt and $16.47 billion in total assets for Q1 2014.
|Company||Long-term Debt to Total Assets Ratio|
Diamondback Energy seems to compare favorably with these two companies on the issue of debt. Although the debt buildup was rapid, the bulk of it comes from a $450 million senior notes offering last fall. The capital was used to pay for mineral acquisitions in the Permian. Nonetheless, this may be a troublesome development if it is the beginning of a trend to favor debt-fueled growth.
Diamondback Energy's CEO and institutional investors could have reasonably pulled back for any or all of the reasons outlined above. They may have also just wanted to lock in their gains from the great run the company has been on since its IPO. However, the lesson for value investors and any Fools is to look closely at Diamondback's debt now and in subsequent quarters, and consider whether the company is a good buy at its current price levels.
Dajahi Wiley has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.