Before I start, please remember that we do great individual stock work for concentrated positions of clients. I have opinions and convictions that I\u2019m more than willing to spew.<\/p>\n
We were very fortunate with the performance of the Compounders sleeve last year and hope to continue that momentum in \u201924. In today\u2019s musing, we\u2019ll be highlighting Aptus\u2019 most recent addition to the portfolio \u2013 Diamondback Energy, Inc. (FANG).<\/p>\n
Compounder Factsheet<\/a><\/span><\/strong> <\/p>\n <\/p>\n Now that we are past earnings, here are a few facts on the market that really stick out to me:<\/p>\n Where does valuation figure into the Magnificent Seven vs the S&P 493 Debate? Is Something Structural Going On?<\/u><\/em> Here\u2019s another stat that I find eye-popping: the Magnificent Seven reinvests 60% of that cash flow into growth capex and R&D. Think about the compounded power of that over time and note that it\u2019s more than 3x what the other 493 S&P companies reinvest. There are elements of winner-take-all at play here, and it\u2019s not something I\u2019m willing to structurally fight \u2013 own more stocks, less bonds, and remain risk-neutral.<\/p>\n My Favorite Valuation Chart <\/p>\n <\/p>\n As always, given that NVDA is a hot topic (and the comments above), let me know if you\u2019d like my written commentary on the stock.<\/p>\n <\/p>\n <\/p>\n Why Did I Decide to Review FANG? <\/em>Many folks have reached out to me\u00a0asking about the company\u2019s recent acquisition of Endeavor (privately held).<\/p>\n One of the biggest things catching my eye in the energy space has been the record amount of mergers & acquisitions, or M&A (XOM\u00a0\u00e0\u00a0PXD | FANG\u00a0\u00e0\u00a0Endeavor | CVX\u00a0\u00e0\u00a0Hess \/ etc.). We are nearly 10 years into the meteoric rise of US Shale, alongside major basins being more mature, we\u2019ve seen inventories start to decline and productivity start to wane. So, to maintain their foothold in the Permian basin and elsewhere, oil majors are snapping up prized plots.<\/p>\n <\/p>\n <\/p>\n From a sector perspective, one of the big rationales for owning Energy was the capital allocation changes happening across the spectrum. This has continued as free-cash-flow yields continue to increase, providing more levers for companies to return cash to shareholders. This is partly a function of capital scarcity due to institutional divestitures and political pressure that has helped constrain Oil & Gas capital expenditures (\u201cCAPEX\u201d). In any event, the result is the highest-ever cash flows which have been helping bolster the return to shareholders via fixed\/variable dividends + share repurchases.<\/p>\n As I mentioned above, the path to new reserves has been the same playbook for many companies, via M&A. Rather than exploring for and\/or developing new projects, large companies are pursuing a more risk-averse strategy of buying existing production. In 2023, the North American energy sector had seen $270B worth of M&A deals.<\/p>\n Given this onslaught of M&A, FANG took advantage of multiple competitors being tied up with other deals to pounce on the crown jewel of private companies in the Permian Basin. Following XOM-PXD pending merger and OXY\u2019s recent acquisition of CrownRock, FANG became the only logical player to take down the long sought-after private. Thus, FANG and Endeavor are merging in what is the fourth energy mega-deal announced in the last six months.\u00a0 The combined entity will be the third largest producer and 5th largest acreage holder in the basin while sitting tied for third in core-inventory locations.<\/p>\n <\/p>\n \u00a0<\/em><\/p>\n However, whereas in the other three, the acquirer trailed the S&P energy sector by an average of -1.15% and the S&P 500 by an average of -2.30% on the day of the announcement, FANG soared, outperforming both by 8.28% and 9.47%, respectively.<\/p>\n Which begs the question, why? Most analysts agreed that FANG paid a fair to full price for Endeavor… it wasn’t like they got a bargain. Perhaps the answer can be found plastered on every single slide of the merger pitch deck put out by FANG, which read “The Must-Own Permian Pure Play.” Haughty, perhaps. Presumptuous, definitely. But when you look at it, they’re right.<\/p>\n With PXD out of the picture, FANG\/Endeavor’s scale and complementary acreage position in the most prolific US shale basin make it the go-to E&P for energy-hunting portfolio managers, like myself. Moreover, in some respects, Endeavor was seen as the ultimate prize. Founder Autry Stephens started the company in 1979, having come from humble beginnings on a peanut and watermelon farm. Long thwarting reported acquisition attempts from multiple public behemoths, Endeavor rose as the major privately held producer in the Permian. His patience paid off; post-transaction, Mr. Stephens’ net worth is pegged at just under $26B, placing him at 64 on Bloomberg’s wealth list.<\/p>\n Hat tip to a member of our own team, Joseph Sykora, CFA, who used to do boots-on-the-ground work in the Permian, so we\u2019ve very much had our ear to the ground in this space.<\/p>\n <\/p>\n <\/p>\n Alongside the announcement, FANG offered up even more good news: they are increasing the base dividend by 7% to $3.60\/share annually. That being said, they also reduced the minimum payout from 75% of free cash flow to 50% of FCF in an effort to quickly reduce debt associated with the deal and provide the company with more financial flexibility going forward. The 75% minimum payout was previously the highest in the industry (along with PXD). We believe this is the smart business decision.<\/p>\n All-in-All: Simply said, FANG bagged a Unicorn.<\/p>\n In our opinion, this deal is an absolute homerun for Diamondback, with the company now asserting itself as the premier pure-play E&P in the country. Other details of the deal we like are the 18-month lock-up for the Endeavor stockholder group which should go a long way towards easing any selling pressure put on by the acquired party. Diamondback now has zero inventory concerns, with a huge quantity of known strong locations alongside a considerable amount of upside should more zones become viable. Overall, we would expect multiple expansions in the wake of the deal as FANG takes their place as the sitting King of the Permian.<\/p>\n Momentum \/ Technicals<\/u><\/em> <\/p>\n <\/p>\n With price and volume confirming direction (up) the trade now becomes one of trend vs fundamental value. Price will, most likely, hang around $180 until its 20 or 50 sma’s catch up to it and continue on trend (up) and look to test the round $200 number before attempting its next major pause.<\/p>\n <\/p>\n <\/p>\n <\/p>\n Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed.<\/em><\/p>\n \u00a0<\/em>This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.<\/em><\/p>\n \u00a0<\/em>The content and\/or when a page is marked \u201cAdvisor Use Only\u201d or \u201cFor Institutional Use\u201d, the content is only intended for financial advisors, consultants, or existing and prospective institutional investors of Aptus. These materials have not been written or approved for a retail audience or use in mind and should not be distributed to retail investors.\u00a0 Any distribution to retail investors by a registered investment adviser may violate the new Marketing Rule under the Investment Advisers Act.\u00a0 If you choose to utilize or cite material, we recommend the citation be presented in context, with similar footnotes in the material and appropriate sourcing to Aptus and\/or any other author or source references. This is notwithstanding any considerations or customizations with regards to your operations, based on your own compliance process, and compliance review with the marketing rule effective November 4, 2022.<\/em><\/p>\n \u00a0<\/em>Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm\u2019s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2403-15.<\/em><\/p>\n <\/p>\n","protected":false},"excerpt":{"rendered":" Topics for this Musing: Quick Market Commentary Stock of the Quarter Before I start, please remember that we do great individual stock work for concentrated positions of clients. I have opinions and convictions that I\u2019m more than willing to spew. We were very fortunate with the performance of the Compounders sleeve last year and hope […]<\/p>\n","protected":false},"author":11,"featured_media":233930,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","content-type":"","inline_featured_image":false,"footnotes":""},"categories":[29],"tags":[291,94,354,160],"class_list":["post-235699","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-equity-research","tag-content-hub","tag-energy","tag-oil","tag-stock"],"yoast_head":"\n
\nCompounder Philosophy<\/a><\/span><\/strong>
\nCompounder Case Studies<\/a><\/span><\/strong><\/p>\nQuick Market Commentary<\/strong><\/h5>\n
\n<\/u><\/em>The PE ratio on the Magnificent Seven is 29x, which places it in the 81st percentile of post-GFC history. The PE ratio on the S&P 493 is 18x \u2013 placing it in the 88th percentile of the same lookback window. So, while I concede that the former is superficially much higher than the latter, based on looking at each cohort relative to its own history, it\u2019s not at all obvious to me that the 493 are all necessarily \u201ccheap\u201d in comparison. In this context, look at NVDA – it has added around $1.7T of market cap over the past 16 months, and the P\/E has barely budged, i.e., earnings are driving the stock\u2019s performance (Think back to our Yield + Growth +\/- Valuation Framework).<\/p>\n
\nThis isn\u2019t breaking news and it\u2019s something I\u2019ve been saying a lot on TV lately: US mega-cap tech companies have some of the biggest and best balance sheets in the world. They generate huge free cash flow and return a large chunk of that to shareholders (recall the recent buyback math for AAPL, GOOG, META, et al \u2013 META actually announced a dividend!).<\/p>\n
\n<\/u><\/em>Only time will tell if the market is \u201covervalued\u201d or \u201cundervalued\u201d, but we don\u2019t think comparing today\u2019s S&P 500 valuation to its history, especially longer-term history, might be the best comparison. A fair value approach to the index based on long-term trends in earnings and cost of equity would have grossly underestimated S&P 500 returns in recent years.<\/p>\n![\"\"](\"https:\/\/aptuscapitaladvisors.com\/wp-content\/uploads\/2024\/03\/SP-500-asset-light-sectors_BofA-22824.png\")
<\/p>\nStock of the Quarter \u2013 Diamondback Energy, Inc. (FANG)<\/strong><\/h5>\n
![\"\"](\"https:\/\/aptuscapitaladvisors.com\/wp-content\/uploads\/2024\/03\/Oil-deals.png\")
<\/p>\n![\"\"](\"https:\/\/aptuscapitaladvisors.com\/wp-content\/uploads\/2024\/03\/Best-in-class_Diamondback-21224.png\")
Source: Diamondback Investor Presentation as of 02.12.2024<\/em><\/p>\n![\"\"](\"https:\/\/aptuscapitaladvisors.com\/wp-content\/uploads\/2024\/03\/Permian-Basin_Raymond-James-2.12.24.png\")
<\/p>\n
\nFANG took a turn for the better when it announced it was acquiring Endeavor Energy Resources on 2\/12, breaking out on 3.5x average volume. This volume has created a floor for FANG @ the $160 level, and further momentum into earnings on 2\/20 pushed it to the $180 area (new ATH). It has historically moved in $20 increments as can be seen in the below chart.<\/p>\n![\"\"](\"https:\/\/aptuscapitaladvisors.com\/wp-content\/uploads\/2024\/03\/FANG-equity_Bloomberg-3.6.24.png\")
<\/p>\nDisclosures<\/strong><\/h5>\n