Diamondback Energy (NASDAQ: FANG) has flown under the radar of many dividend investors. That’s causing them to miss out on its high-octane dividend. The oil company pays a rapidly rising base dividend. On top of that, it routinely pays a variable dividend, which can be quite sizable.
It gave investors a monster raise last quarter, paying a total of $3.37 per share (more than 300% above the second quarter’s level). While its payout will fluctuate in the future, investors seeking big-time income potential should take a closer look at this oil dividend stock.
Becoming a cash-flow machine
Diamondback Energy spent years building a leading oil and gas production business centered on the low-cost Permian Basin. The company spent billions of dollars to acquire land in the region and develop wells and related infrastructure. Those investments have started to pay off in recent years by turning it into a cash-flow-producing machine.
Thanks to its scale and low-cost position, Diamondback Energy only needs oil to average about $32 per barrel to generate enough cash flow to fund the wells required to maintain its current production rate. With crude prices currently in the $70s, it’s producing significant excess cash flow. At that price point, Diamondback can generate more than $2.7 billion in free cash flow per year.
Returning its cash flow to shareholders
Diamondback Energy targets to return more than 75% of its annual free cash flow to investors. The foundation of its capital return program is its base dividend. The company considers that payment as a “debt” it owes shareholders. Because of that, it goes to great lengths to protect that payout. It does so by maintaining a strong balance sheet and keeping the payout to a level it can sustain on the cash flows it can generate at an average oil price of $40 per barrel.
The company increased its base dividend payment by 5% in July, pushing the quarterly rate to $0.84 per share ($3.36 annually). That raise continued the steady upward trend in the base payment. Diamondback has grown its base dividend at an industry-leading 9% average quarterly compound annual rate since 2018.
On top of the base dividend, Diamondback returns additional cash to shareholders by paying variable dividends and repurchasing shares. It has the flexibility to switch between the two depending on market conditions to achieve its 75% capital return target rate. For example, during the second quarter, Diamondback opted to plow the bulk of its excess cash into repurchasing shares ($321 million of its $547 million in free cash flow). After adding the base dividend, Diamondback returned more than 75% of its free cash flow to investors through those two buckets and thus didn’t pay a variable dividend.
However, the company shifted gears in the third quarter. Thanks to higher oil prices, it produced $884 million in free cash. Those higher oil prices fueled a meaningful rally in its stock price. As a result, the company only bought back $56 million in shares. It used its remaining excess cash to pay a monster variable dividend ($2.53 per share). Adding the base dividend pushed its total payout to $3.37 per share.
Given the flexibility of its capital return program, Diamondback Energy might not always pay a big variable dividend. However, it will likely continue to grow its base dividend at an above-average rate while sprinkling in a few sizable variable dividends when market conditions permit. Because of that, it has the potential to produce a high-octane income stream in the coming years.
Steady base income with monster upside potential
Diamondback Energy is an intriguing dividend stock. It pays a solid base dividend (currently yielding 2.2% compared to 1.5% for the S&P 500) that should continue growing at an above-average rate. On top of that, it routinely pays significant variable dividends. Those two payouts should add up over the years, making Diamondback a stock that dividend investors won’t want to miss.
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Matthew DiLallo 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.
Are You Missing Out on This Energy Stock’s Monster Dividend Raise? was originally published by The Motley Fool
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