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This Oil Stock Crushed It in 2017, but It Could Do Even Better in 2018

By Matthew DiLallo - Jan 25, 2018 at 12:36PM

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Diamondback Energy was one of the few oil stocks to beat the market last year, and it’s just getting started.

Diamondback Energy (FANG -0.24%) delivered a market-crushing return last year, gaining nearly 25%, which outpaced the more than 19% return from the red-hot S&P 500. That outperformance is even more impressive considering that most oil stocks lost value last year after investors bailed on the sector when oil prices tumbled during the summer. That said, crude came roaring back by year-end, which catapulted Diamondback Energy's stock because of how briskly it's growing output.

That said, as good as Diamondback's performance was last year, two potential catalysts could make 2018 an even better year.

An oil pump jack with an orange sunset in the background.

Image source: Getty Images.

Stunning growth at $50 oil, "unprecedented growth" at $65?

Through the third quarter of last year, Diamondback Energy's production was up a jaw-dropping 89% year over year. While that was partially due to a needle-moving acquisition at the end of 2016, the oil producer organically increased output 10% in just the third quarter. That put the company on pace to beat its full-year guidance by 3%. What was impressive about that organic growth rate is that the company funded it entirely with operating cash flow. In fact, it had increased production 175% in the last 11 quarters while living within its means. That's quite a feat considering that crude had been below $50 a barrel for much of that time.

While the company hasn't put out official guidance for 2018, it was on pace to utilize 10 drilling rigs this year under the assumption crude would be in the $50s, which would maintain its currently brisk pace. However, with oil now in the mid-$60s, Diamondback Energy should generate more cash that it could use to accelerate its growth rate, with it having the resource base to deliver "unprecedented growth" for years to come, according to CEO Travis Stice. In fact, at $60 oil, the company could run 18 to 20 rigs, which gives it the potential to unleash a torrent of oil production in 2018 that could fuel explosive earnings growth.

A close-up of drill pipes with oil workers and a rig in the background.

Image source: Getty Images.

Scaling up to new heights

Diamondback Energy has more than 4,500 drilling locations across the Permian Basin that are highly profitable at $60 oil. That's a massive inventory for a company that was on pace to complete about 125 new wells last year, giving it years of growth. However, while it has plenty of organic growth ahead of it to create value for investors, it recently told analysts at Seaport Global that it's interested in boosting its scale by merging with a producing rival that has an attractive resource position but hasn't unleashed its full potential.

A company like Energen (EGN), for example, would seem to fit its criteria. Its shares have fallen about 8% over the past three years, while Diamondback's rocketed nearly 95%. That slump came even though Energen's output was on pace to rise 34% last year. Because of that, investors value Energen at half what they value Diamondback, despite holding similarly sized resource bases and producing at around the same rate, which would make a transaction like that highly accretive to Diamondback. Meanwhile, with more than 4,200 future drilling locations, all near Diamondback's land, Energen would make strategic sense. If Diamondback can make a needle-moving deal for a company with those attributes, it could ignite the stock because the deal would almost instantly add value.

A high-octane oil stock

Diamondback Energy has been among the fastest-growing oil stocks in the country. What's so impressive about that is the company only needed $50 oil to fuel that growth. With oil now in the mid-$60s, the company could accelerate and deliver top-tier earnings growth this year. On top of that, it's on the prowl for a needle-moving deal, which could give it even more fuel to grow earnings. Those two factors suggest that 2018 could be a huge year for the company.

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