February 14, 2018, by Liam Denning
I know it’s Valentine’s Day, but you shale investors sure are some cheap dates.
Diamondback Energy Inc. is a darling of the Permian basin, which is itself the darling of the shale world. On Wednesday, it reported its 11th set of quarterly earnings in a row beating the consensus forecast. It also announced a massive dividend hike — massive in the sense that it didn’t have one before. Here’s how the 50 cents Diamondback will pay on each share in 2018 stacks up against the competition:
Not the most compelling dividend yield, there. Granted, it’s way higher than fellow Permian darling Pioneer Natural Resources Co. — and that after the latter quadrupled its dividend — but still meager compared to the market or the likes of Occidental Petroleum Corp. (which also reported results Wednesday).
Which tells you no one is really owning Diamondback for a quarterly dividend check. So why bother?
Mostly, it’s marketing. A debate has been raging around the exploration and production sector since last summer about whether these companies should prioritize investing in growth or returning more capital to shareholders.
Shale drilling is highly capital-intensive. And in its first phase before the oil crash, the standard model was to reinvest every dollar of cash flow — and whatever you could raise from selling bonds or new equity — in more land and fracking. In return, investors sought evidence of growth and greater efficiency in terms of lower costs and more-productive wells. Since the crash, with many generalist investors abandoning the energy sector and balance sheets coming back into focus, the emphasis has tilted toward efficiency: When oil prices are lower, lower costs are mandatory.
Diamondback has never been shy about tapping investors for extra capital. Including its 2012 IPO, it has conducted 17 public equity offerings for a total of $4.9 billion, according to data compiled by Bloomberg; the latest was in August. Even on that latest one, though, anyone who bought into each of those sales is up:
The biggest reason for that performance is that, since 2011, Diamondback’s production has risen by 90 percent — every year, compounded. At the same time, its unit costs have fallen by more than two thirds:
If an E&P company can deliver those results, a dividend is largely superfluous; it’s better to leave the marginal dollar in the hands of management.
But when the dividend amounts to just $49 million on Ebitda of more than $900 million last year — which is forecast to rise by 56 percent this year — no one’s going to really care. And if having a payout allows some funds otherwise unable to own Diamondback to consider it, then so much the better. The payout is really just a boast of growth mixed with productivity.
The same reasoning goes with Pioneer’s princely yield of 0.05 percent and its share buyback, also announced last week, equating to an additional 0.3 percent — albeit, the company is also making amends after operational slip-ups last year. Conversely, ConocoPhillips offers a yield of about 2.1 percent, with a buyback program on top worth an extra 3 percent. Diversified and much bigger than Diamondback or Pioneer, Conoco can’t offer the same growth proposition, and therefore balances it with a bigger distribution and a commitment to funding capex and distributions at today’s oil prices.
Which leads us to Occidental, which yields a chunky 4.5 percent but got dinged Wednesday for missing forecasts on production and capex. The dividend, which took almost half of Occidental’s cash from operations in 2017, provides a reasonable floor for the stock, but isn’t a shelter if execution disappoints.
For all the rhetoric and gestures toward returns, payouts are just another manifestation of what E&P investors have always really desired: high growth and efficient use of their money.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners. Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal’s “Heard on the Street” column. Before that, he wrote for the Financial Times’ Lex column. He has also worked as an investment banker and consultant.