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Motley Fool Issues Rare “All In” Buy Alert
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It’s Friday, and it looks like oil stocks are going to end this week on a down note. As of 10:20 a.m. ET, shares of Chevron (CVX -0.60%) are trading 1.8% below Thursday’s close, while oil industry bellwether ExxonMobil (XOM -0.87%) is down 2.1%, and independent oil producer Diamondback Energy (FANG -3.44%) leads the pack lower with a 5.6% loss.
The most obvious culprit for this morning’s selling — for all three of these energy stocks — is the falling price of oil. As OilPrice.com reports today, the cost for a barrel of West Texas Intermediate crude is falling for a third straight day, down 4% — and down nearly 10% from Tuesday at $78.37 a barrel.
Brent crude, the international benchmark, is selling off similarly, down 3.5% today, and down nearly 8% from Tuesday’s peak at $86.61 a barrel — it’s down even more from a high north of $98 a barrel, set on Nov. 4.
OilPrice.com blames the rising value of the U.S. dollar for some these price declines. (As the dollar gets stronger, each $1 spent buys relatively more oil, such that the cost per barrel declines.) Also pushing prices down are generalized worries that China’s continued zero-COVID policies will keep growth subdued in that country, even as recession worries slow the U.S. economy — both factors that tend to depress demand for oil, and therefore oil prices.
This could be particularly troubling for Diamondback this week (if the trend continues), because on Wednesday, Diamondback Energy announced a definitive purchase agreement to acquire Lario Oil & Gas Company’s Lario Permian assets in a cash-and-stock transaction valued at roughly $1.5 billion. On the plus side, this transaction, combined with other acquisitions in the works, will give Diamondback an additional 50 million barrels of oil-equivalent (i.e., oil and gas) production. However, it will cost Diamondback more than $800 million worth of cash (that indebted Diamondback doesn’t presently have), requiring the company to take on more debt at the same time as it issues more dilutive shares of stock.
And all of this is happening in the context of an oil market where prices are — for now at least — falling, not rising.
So you can see why Diamondback shareholders might be feeling a bit nervous this morning.
The good news is that, while Diamondback Energy has some troubles with its stock — notably $5.6 billion in debt and only a few million dollars of cash on its balance sheet — the stock’s valuation seems to reflect these risks already. Valued at just 6.5 times earnings, and paying a rich 5.5% dividend yield, Diamondback’s dividend alone seems nearly enough to justify the stock’s price, even assuming zero growth in earnings. For context, Diamondback’s dividend is nearly twice the 3.1% dividend yield that Chevron pays, or Exxon’s 3.2%.
When you consider further that analysts polled by S&P Global Market Intelligence do expect Diamondback to grow at least modestly over the next five years (a 2% growth rate is expected), and that the company is generating strong free cash flow (about $3.2 billion over the last 12 months) with which to service and pay down its debt, I actually think that the risks and rewards on this stock look nicely balanced right now.
Diamondback may be one of the weaker performers in the oil patch Friday morning — but I also suspect this is a bet that could pay off for investors.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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