Better Energy Stock: Diamondback Energy vs. Chevron

Key Points

• Chevron's integrated business and its rock-solid balance sheet help secure its dividend.

• Diamondback Energy is a well-run oil and gas company that offers good upside due to the potential for higher oil prices.

• Ultimately, the decision comes down to each individual's risk profile, but one stock stands out as a clear winner for passive income-seeking investors.

• 10 stocks we like better than Diamondback Energy ›

Comparing a pure-play exploration and production in the Permian Basin, Diamondback Energy (NASDAQ: FANG), with an integrated energy major, Chevron (NYSE: CVX), sheds light on many of the questions that oil and gas-focused investors face in the coming years. Let's take a look at which company might suit which type of investor better.

The role of oil prices

There's no getting around this question when investing in energy stocks, but the answers to it may not be immediately apparent. It's important to note that both these companies are very well run and pride themselves on a relatively low operating "break-even" oil price. This price represents the lowest price of oil needed to cover the cost of the company's operating expenses, existing wells (maintenance capital spending), and base dividend.

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Chevron's break-even price for oil is in the $30 per barrel range accoring to a Wood Mackenzie survey. Diamondback's management estimates its equivalent break-even price is $37 per barrel.

That would appear to give Chevron the upper hand. However, consider that Chevron is an integrated major with substantial downstream and chemicals operations, which tend to perform well with a lower oil price; these factors are included in the break-even calculation.

On the other hand, Diamondback is purely an exploration and production company. Moreover, Diamondback utilizes hedging to mitigate downside exposure to oil prices. Its hedges currently apply down to a price of oil of about $55 per barrel, meaning it has upside exposure to a price of oil above $55 per barrel.

As such, you can think of Chevron's dividend (currently yielding 4.8%) as safe down to $30 per barrel, and Diamondback's base dividend (currently yielding 2.9%) as safe down to $37 per barrel. Consequently, if you are the type of investor primarily looking for yield and wanting to sleep safely at night, Chevron is the better investment for you.

Don't forget the upside

The flip side of the argument is that Diamondback has more exposure to a higher oil price, which is what one might expect, given that it's an exploration and production company.

To provide some context for how this works, here's a look at Diamondback's management's estimated adjusted 2025 free cash flow (FCF) across a range of oil prices. For reference, Diamondback aims to return 50% of FCF to shareholders in the form of dividends (base and variable) and share buybacks. It has $1.845 billion remaining as part of a $6 billion share buyback authorization program.

As of its first quarter, Diamondback made $829 million in share buybacks, equivalent to about $2.80 per share. Therefore, if management decided not to make any more buybacks and pay the remaining 50% in full-year FCF in dividends (base of $4, plus a variable dividend), then it could offer $5.20 in dividends, yielding 3.8%, assuming a price of oil of $60 a barrel.

That theoretical figure rises $8.70 in dividends, yielding 6.4%, assuming a price of $80 a barrel. See what I mean by Diamondback having more upside exposure to the price of oil?

Data source: Diamondback Energy presentations. Table by author.

In case you are wondering, based on these assumptions, the price of oil would have to be approximately $67 per barrel to get Diamondback's dividend yield to be equivalent to Chevron's current yield -- curiously enough, that's roughly the current price of oil now.

Diamondback or Chevron?

Ultimately, dividend-focused investors and those concerned about being overly exposed to oil prices will favor Chevron. In addition, Chevron's diversified operations (its production in the Permian is comparable to Diamondback's, but it has substantial other global assets, plus midstream and downstream operations) give it a place to focus its investment, even in the event of a sustained fall in oil prices.

Image source: Getty Images.

In contrast, other than reducing capital investment in response to lower prices (something Diamondback has already done this year), it's hard to think of what significant move a company like Diamondback can make.

That said, many investors buy oil stocks precisely because they want exposure to the upside of oil, and Diamondback is a high-quality operator that has taken measures to limit its downside exposure. As such, nothing is stopping you from buying both stocks, as they are both attractive for passive income-seeking investors.

Should you invest $1,000 in Diamondback Energy right now?

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool has a disclosure policy.