Does Diamondback Energy Have a Debt Problem?

Photo credit: Diamondback Energy

Earlier this week, Diamondback Energy announced an agreement to acquire 13,136 net acres in leasehold interests in the Permian Basin for approximately $538 million. This acreage is in the core area of the play. The 94 net producing wells that the company will acquire boasted a net production of 2,173 barrels of oil equivalent per day in May.

Although Diamondback Energy intends to finance this purchase with a mixture of equity and debt, the company's rapid accumulation of debt in the past year and a half may signal a trend of debt-fueled growth that could pose problems in the future.

Growing debt
At year-end 2012, Diamondback Energy had just $193,000 of long-term debt -- essentially nothing for a company that had, at the time, more than $600 million in assets, $75 million in revenue, and $59 million in gross profit.

At year-end 2013, the company had a whopping $460 million of long-term debt. The total has increased to $587 million as of the first quarter of 2014.

Source: Diamondback Energy Total Long Term Debt (Quarterly) data by YCharts

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 of assets.

Although the debt buildup was rapid, the bulk of it comes from a $450 million senior notes offering last fall. That money was used to pay for mineral acquisitions in the Permian. Diamondback Energy projected these mineral interests would generate free cash flow of between $70 million and $80 million this year.

Furthermore, the $450 million in senior notes offered last fall reaches maturity in 2021. The company's remaining $137 million of debt is a revolving line of credit. This suggests that, currently, the company's debt is not a pressing issue.

Diamondback Energy's relative debt load
Being that Diamondback Energy is an oil and natural gas exploration and production company focused on the Permian Basin, its debt level is best compared to that of other companies with a similar profile. One such company is Concho Resources, which focuses its operations on the Permian Basin. Another company, LINN Energy, operates in the Central and Western United States but considers the Permian to be one of its core areas.

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. A considerable portion of the company's long-term debt is tied to its large-scale acquisitions of Marbob Energy in 2010 and Three Rivers Operating Company in 2012. Aside from these purchases, Concho Resources has not engaged in a significant amount of debt-fueled growth recently. Approximately $3.3 billion of the company's debt matures in 2021 or later. As with Diamondback Energy, the dates of maturity for Concho Resources' debt suggest that its debt isn't cause for concern at the moment.

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. The vast majority of this debt matures between 2019 and 2022. Senior notes worth approximately $205 million reached maturity last month. It appears that liquidity shouldn't be a serious concern with LINN Energy right now, but given its high debt ratio, investors ought to carefully watch its debt levels and cash flows.

Overall, Diamondback Energy compares favorably with these two companies on the issue of debt. None of the companies have a large amount of debt that matures in the near future, but Diamondback Energy holds a substantially lower long-term debt to total assets ratio.

Foolish conclusion
Despite a comfortable long-term debt to total assets ratio at the moment and debt maturity dates that are quite distant, investors will want to keep a close eye on Diamondback Energy's debt. If the company is developing a preference for debt-fueled growth, it may be setting itself up for very difficult times in the event of oil and gas price decreases in the coming years.