BofA's take on FANG Stock Buyback - Sept 17

[dan_s]

BofA Equity Research: Buybacks as a mechanism to exploit the value gap

Diamondback (FANG) has announced a $2bn buyback authorization, about 14% of its
current market cap. It has also provided perhaps the most articulate justification of why
it is choosing buy backs as a clear statement on its view of the value of its business,
underlined by a 24% current FcF yield. Recall that with 2Q21 earnings, management
committed to return 50% of FcF to shareholders; but it did not provide a framework
avoiding the current practice of variable distributions that at the simplest level, we view
as negative for long term equity value, for an E&P business with a finite inventory.
Conversely, if value can be defined with confidence by a transparent business model, it
follows that the decision to return cash to investors via buy backs makes sense. With the
shares trading about 30% below our view of fair value, we agree. Retain Buy, PO $114
with management putting in place a mechanism that can exploit the value gap versus
current levels

Buybacks over variable dividend, for as long as the stock is cheap
Quoting management’s explanation of its capital return: ‘…while our consistent and
growing base dividend remains our primary means of returning capital, we plan to
opportunistically repurchase shares with the remaining FcF allocated to our stockholders
when we expect the return on that repurchase to be well in excess of our cost of capital at
mid-cycle commodity prices, which is the case today. We will cease repurchasing stock and
return excess FcF in the form of a variable dividend when we expect the return on that
repurchase to be less than our cost of capital at mid-cycle commodity prices ….’.

Drawing a line in the sand on the best route to return cash
As a footnote, by our estimates before this announcement, FANG’s net debt would be
cut in half by end-‘22 from about $7bn at end 2Q21; on our estimates its capacity for
buy backs could be exhausted within two years. Note FANG anticipates the pending
Bakken sale to close within weeks with expected proceeds (BofAe about $700mm) it
intends to repay $650mm in callable bonds. All in all, we expect a positive response from
the management – with FANG management drawing a line in the sand on the return of
cash debate vs peers
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My current value of FANG is $140/share.