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Permian pair Diamondback, Viper catching stock analysts' attention

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Permian pair Diamondback, Viper catching stock analysts' attention

Energy equity analysts see a lot of potential in a pair of growing Permian Basin players with ominous names that have been outperforming competitors: Diamondback Energy Inc. and its master limited partnership, Viper Energy Partners LP.

Diamondback, based in Midland, Texas, is a Permian-specific firm trading under the ticker symbol FANG that has focused production on several unconventional plays in the area. Shares of the company closed at $99.09 on Oct. 6, up about $13 from a slide that began after a rough second-quarter earnings season for Permian producers.

Williams Capital Group principal Gabriele Sorbara said the slide was through no fault of Diamondback's. He said Diamondback's second quarter was "excellent … on all fronts."

"[Diamondback] reported [second-quarter 2017] clean EPS and [distributable cash flow per share] of $1.25/$2.19, above our estimate of $1.03/$2.13 and consensus of $0.92/$1.99." He noted that second-quarter production came in above Williams Capital and consensus estimates.

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Diamondback also impressed Sorbara by reporting lower lease operating expenses, production taxes, and transportation and other costs than anticipated.

Since the end of the second quarter, Williams Capital has increased its 2017, 2018 and 2019 production estimates by 1.8%, 4.4% and 5.5%, respectively, significant totals for a company already active in the Permian.

U.S. Capital Advisors noted Diamondback has consistently outperformed other producers in the basin while keeping costs in check.

"In a world where macro uncertainty dominates, the ability to efficiently and predictably convert rocks into cash flow has become exceedingly important to the equity market. While past results don't always predict the future, FANG has been an execution machine over the past few years, exceeding consensus oil production estimates in 7 of the last 8 quarters by an average margin of 4%," said Cameron Horwitz, U.S. Capital's managing director and head of exploration and production research.

In a 10-year model, U.S. Capital estimated Diamondback growing its oil production from about 58,000 barrels per day in the second quarter to 275,000 bbl/d by 2027.

"This represents a ~17% [compound annual growth rate] and is roughly equivalent to [EOG Resources Inc.]'s domestic oil production in 2016 ($56 billion EV)," the firm said. "Even with our CAPEX assumption ramping up to ~$2.5 billion in the middle of next decade (from ~$900 mm in '17), we see FANG generating ~$10 billion of cumulative [free cash flow] through 2027. To put in context, this is roughly in-line with its market cap and means FANG could theoretically buy back all its outstanding shares."

The company is aided by its MLP subsidiary Viper, which trades under VNOM and has bought up mineral rights in the play outright, reducing Diamondback's leasehold costs. The move to purchase the acreage, U.S. Capital said, works well for the long term. "While [exploration and productions] relish the stacked pay nature and decadal resource outlook in the Permian, they are also exposed to inflationary trends on the CAPEX side of the ledger. We see mineral ownership as one of the most material ways to create value in the Permian as mineral owners do not pay direct operating costs or capital expenditures on wells drilled," the firm said.

Viper units have largely traded between $14 and $19 over the past year, and never higher than the $19.36 reached Oct. 6. According to Mizuho analyst Tim Rezvan, there may be more room for the MLP's stock to grow.

"Viper's exposure to Diamondback, a reliable operator, provides some assurance on growth. We continue to focus on robust distributable [cash flow per unit] growth in 2018 ($1.86/unit, +34% y/y) as the key variable that is likely to attract incremental investor attention to VNOM units," he said, putting the firm's price target for Viper at $28 per share.