Fitch Ratings has assigned a 'BBB' rating to Diamondback Energy, Inc.'s proposed senior unsecured notes due 2033.

Diamondback intends to use the proceeds from the notes, approximately 5.86 million shares of Diamondback common stock and cash on hand to fund the purchase price of the recently announced FireBird Energy LLC acquisition. The transaction is expected to close in late 4Q22.

Diamondback's 'BBB' rating reflects its high-quality, oil-oriented Permian production and a proved reserve base, competitive full-cycle break-even oil prices, expectation for substantial FCF generation and a sub-1.5x mid-cycle leverage profile. Credit concerns are limited and include Diamondback's single-basin focus, resulting in limited geographic, operational and hydrocarbon diversification.

Key Rating Drivers

Credit-Neutral Transaction: The company's proposed notes issuance and announced acquisition of Firebird is neutral to the credit profile given the large equity issuance, representing approximately 50% of the total purchase price, and expectation for further debt reduction in the near-term. Fitch expects the company will utilize its reserve-based lending credit facility (RBL) to fund a portion of the cash payment for FireBird although borrowings are expected to be reduced shortly after close given the robust FCF generation at current commodity prices. Management has also announced a $500 million non-core asset sale target by YE23 with proceeds earmarked for further debt reduction which should enhance credit metrics.

High-Quality, Accretive Assets: Fitch believes the FireBird acquisition is accretive to Diamondback's asset profile given the high quality, undeveloped inventory and the adjacent acreage position which should enhance production and capital efficiencies and improve overall returns. The transaction adds approximately 68,000 net acres in the Midland Basin, 25 mboepd of production (75% oil) and an estimated 350 adjacent locations (approximately 10 years of inventory life at current development pace) which compete for capital in Diamondback's development plan. Management intends to scale back the rig count from three rigs to one rig in 2023 which will allow for maintenance of current production and strong FCF generation.

Robust FCF, Credit-Conscious Allocation: Fitch's base case forecasts approximately $3.5 billion of FCF after base dividends in 2022, assuming Fitch's WTI oil price and Henry Hub gas price assumption of $95/bbl and $7.00/mcf, respectively. Diamondback's robust FCF profile will continue throughout the rating horizon with pre-dividend FCF of over $1.0 billion at our long-term price assumptions ($50/bbl and $2.75/mcf) through relatively flat production in 2023 and low to-mid-single-digit production growth thereafter. Fitch projects the company will still generate positive post-dividend FCF at approximately $30-$35/bbl WTI and estimates that FCF improves by roughly $50 million-$75 million for each $1/bbl increase in WTI oil prices.

Sub-1.5x Mid-Cycle Leverage: Fitch's base case forecasts gross debt/EBITDA of below 0.8x in 2022 and 0.9x in 2023 which moderates towards approximately 1.4x at Fitch's $50 mid-cycle WTI price assumption and supports the 'BBB' rating. Fitch believes the high-quality asset profile, accretive FireBird acquisition and currently supportive pricing environment combined with Diamondback's hedge position provides support for FCF generation and gross debt repayment toward management's long-term consolidated gross debt target of $4.5 billion.

Supportive MLP Affiliates: Diamondback has one publicly traded MLP affiliates with its approximately 54% ownership in Viper Energy Partners, LP and now fully owns Rattler Midstream LP. Both entities support Diamondback's advantaged unit economics, as Rattler has core water infrastructure assets, which reduce the company's cost structure in all seven of Diamondback's core operating areas. In addition, Diamondback's well economics are higher on Viper acreage given the advantaged net revenue interest. Both entities also provide a source of contingent liquidity.

Derivation Summary

Diamondback is among the largest Permian Basin-focused independent exploration and production companies with a considerable, high-quality footprint within the Delaware and Midland Basins. Diamondback's 2Q22 average production of 381 mboepd (79% liquids) is less than Pioneer Natural Resources Co., (BBB+/Stable; 643 mboepd) and Devon Energy Corp. (BBB+/Stable; 616 mboepd) but similar to Continental Resources, Inc. (BBB/Stable; 400 mboepd) and larger than Endeavor Energy Resources, L.P. (BBB-/Stable; 258 mboepd).

Fitch believes Diamondback's Permian Basin focus, particularly the company's considerable, contiguous positions, provides an opportunity to focus capital, optimize drilling and completion techniques to maximize returns, and provides operational flexibility in commodity price downturns. However, the limited geographic and hydrocarbon diversification can heighten asset-level risks in the longer term.

Diamondback's standalone, unhedged half-cycle netbacks of $64.4/boe (81% margin) for 2Q22 was slightly below Midland peer Endeavor ($68.4/boe; 85% margin), in-line with Pioneer ($64.8/boe; 82% margin), but stronger than Devon ($57.9/boe; 79% margin) and Continental ($61.0/boe; 80% margin) and is toward the higher end of the Permian peer average. Diamondback's 2022 forecast leverage of sub-1.0x is also in-line with the peer average at Fitch's $95/bbl WTI price assumption.

Key Assumptions

WTI Oil price of $95/bbl in 2022, $81/bbl in 2023, $62/bbl in 2024 and $50/bbl thereafter;

Henry Hub natural gas price of $7.00/mcf in 2022, $5.00/mcf in 2023, $4.00/mcf in 2023 and $3.00/mcf in 2025;

FireBird transaction closes in late 4Q22;

Average production of 380 mboepd in 2022 followed by acquisition growth in 2023 and annual low-to-mid single digit growth thereafter;

Post-close capex of approximately $2.3 billion in 2023, following growth-linked spending thereafter;

Prioritization of FCF toward gross debt reduction;

Measured increases in shareholder returns following achievement of net debt targets.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Increased size and scale evidenced by production trending above 550 mboe/d while maintaining economic drilling inventory;

Standalone mid-cycle debt/EBITDA below 1.5x on a sustained basis;

Standalone debt/PD at or below $4.00/boe on a sustained basis.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Standalone mid-cycle debt/EBITDA above 2.5x on a sustained basis;

Standalone debt/PD above $5.50/boe on a sustained basis;

Material loss of operational momentum leading to lower than expected production volumes (250 mboe/d or lower) over a sustained period.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Ample Liquidity: Standalone cash and equivalents were approximately $21 million as of 2Q22, excluding approximately $4 and $18 million held at Viper Energy Partners LP and Rattler Midstream LP, respectively. Supplemental liquidity is provided by the company's unsecured $1.6 billion revolver due 2026 which only $33 million was drawn at 2Q22.

Fitch expects the company will utilize RBL capacity to fund a portion of the cash consideration of the FireBird transaction, but borrowings are expected to be repaid shortly after close. Additional potential liquidity sources include noncore E&P asset sales or other activities with Rattler and Viper affiliates.

Issuer Profile

Diamondback is an independent energy company engaged in the exploration and development of onshore U.S. oil & gas properties with a core position in the Permian basin consisting of 414,000 net acres.

Date of Relevant Committee

19 April 2022

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Diamondback has an ESG Relevance Score of '4' for Group Structure as the company has a complex group structure with one separate MLP structure related to Viper Energy Partners, LP. This has a negative impact on the credit profile and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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