What happened
Shares of oil producer Diamondback Energy (FANG -0.77%) soared by 20.4% in May, according to data provided by S&P Global Market Intelligence. Several catalysts fueled that rise, including higher oil prices, earnings, an acquisition, and an analyst upgrade.
So what
Crude oil prices continued their ascent in May. West Texas Intermediate crude, the primary U.S. benchmark, rose by 9.5% during the month to finish at $114.67 per barrel. Strong demand for gas as travel rebounds is driving prices higher because supplies remain constrained, especially following Russia's invasion of Ukraine earlier in the year. While OPEC and its partners recently pledged to start pumping more oil, that hasn't done anything to cool off prices.
Image source: Getty Images.
Higher oil prices are proving to be a boon for Diamondback Energy. Last month, the oil company reported its first-quarter results. One of the highlights was that it generated $974 million in free cash flow, nearly triple what it produced in the year-ago period. That gave it more money to return to shareholders, given its pledge to send them half its free cash flow each quarter. Diamondback made good on its promise by increasing its regular dividend by 17%, repurchasing some shares, and declaring a massive variable dividend. It used the other half of its free cash flow to drill more wells, strengthen its balance sheet, and acquire additional drillable land.
Those strong results led Barclays analyst Jeanine Wai to upgrade Diamondback Energy's stock from equal weight to overweight. The analyst viewed the report as the "clearing event" the stock needed because it suggests cash returns will rise even more in the second half of the year.
Finally, the oil company announced an agreement to acquire all the outstanding shares of its publicly traded midstream subsidiary Rattler Midstream (RTLR). The all-stock deal will see Diamondback pay a 9.3% premium to Rattler's trading price over the prior 30 days. Diamondback made the decision in light of the dramatic transformation that has taken place in the energy industry since it took Rattler public in 2019. The deal will enable both companies to benefit from the simplicity and scale of the larger combined entity.
The deal did lead Wells Fargo analyst Nitin Kumar to lower the bank's price target on Diamondback from $204 a share to $200 a share, though he kept his overweight rating on the stock. The analyst noted that the deal will be about 2% dilutive to Diamondback's net asset value. However, it simplifies the corporate structure, potentially accelerates the repayment of $700 million of Rattler's debt, and opens the door for further cash returns to shareholders.
Now what
Diamondback Energy is cashing in on higher oil prices, and generating a gusher of free cash flow, half of which it's returning to shareholders each quarter. And if crude prices remain elevated, the stock could keep rising.
