Better Permian Basin Oil Stock: Concho Resources Inc vs. Diamondback Energy Inc

The Permian Basin, which stretches across parts of western Texas and southeast New Mexico, is one of the largest oil fields in the world. It's also the fastest growing, with oil production expanding at an annualized pace of 800,000 barrels per day in the past year, which represents more than half of global production growth. While some pipeline issues will cause the region to slow its pace over the next year, the Permian has the oil-rich resources to continue fueling high-octane growth for years to come.

Because of that, oil companies focused on the Basin have the potential to deliver big-time returns for investors in the future. Two producers worthy of attention are Concho Resources (NYSE: CXO) and Diamondback Energy (NASDAQ: FANG) since they are among the largest oil companies solely focused on developing the Permian. While both should thrive in the coming years, one stands out as the better Permian option to consider buying for the long haul.

A closer look at Concho Resources

Concho Resources is the largest oil company solely focused on the Permian. The company produced an average of 229,000 barrels of oil equivalent per day (BOE/D) during the second quarter, which was up 26% year over year and just behind the 272,000 BOE/D produced by Pioneer Natural Resources (NYSE: PXD) in the Permian last quarter. However, with Concho Resources recently completing the acquisition of RSP Permian -- which would have boosted its output to 296,000 BOE/D during the quarter -- it has now vaulted past Pioneer as the top pure-play producer in the region.

That transaction is one of several Concho has completed over the past few years, which has significantly increased its scale in the Permian, where it now holds 26,000 total future drilling locations across its 642,000 net acres. That position should enable Concho Resources to continue delivering 20% annual production growth while living within cash flow. In addition, the company maintains an investment-grade balance sheet, backed by a low leverage ratio of less than 1.5 times debt to EBTIDA. That combination of balance sheet strength and organic growth upside should fuel compelling returns for investors as long as oil prices cooperate.

A closer look at Diamondback Energy

Diamondback Energy has quickly climbed the leaderboard in the Permian over the past five years by making eight acquisitions that have now totaled more than $15 billion. The largest is its recently announced merger with Energen (NYSE: EGN). The $9.2 billion deal will make Diamondback the third-largest pure-play producer in the Permian by boosting its production to more than 215,000 BOE/D. Further, after adding Energen's resources into the fold, the combined company will hold 390,000 net acres that will have more than 7,000 high-return drilling locations remaining. Meanwhile, even with all of its wheeling and dealing, Diamondback Energy has maintained a strong balance sheet, backed by a leverage ratio of just 1.1 times debt to EBITDA.

Diamondback Energy's aim is to deliver peer-leading returns and growth on a per-share basis. The company intends to achieve this goal by focusing on generating free cash flow so that it can accelerate the amount of money it returns to shareholders above its current dividend.

One thing stands out

On an apples-to-apples basis, Concho Resources and Diamondback Energy look very similar, as both own sizable positions in the Permian that should fuel high-octane growth in the coming years. However, one key difference between the two is how they plan to allocate capital in the future. Concho currently intends to reinvest nearly all of its cash flow into drilling new wells, while Diamondback plans to allocate an increasing portion of its cash toward shareholder returns, which could include increasing its dividend and buying back shares.

That's worth noting given the historical outperformance of companies that return cash to investors. Dividend growth stocks, for example, have generated an average annual total return of 9.89% going all the way back to 1972, versus just a 2.39% total annual return for nonpayers, according to a study by Ned Davis Research. Meanwhile, oil companies with needle-moving buybacks have significantly outperformed their peers in the last year. While that past performance doesn't guarantee future success, it does seem to tilt the scale in Diamondback's favor.

This extra boost could drive outperformance

Diamondback Energy and Concho Resources have similar game plans in that both have complemented organic growth with a steady diet of acquisitions. However, where they differ is that Diamondback has started focusing more attention on increasing shareholder value by returning a larger share of its free cash flow to investors. Diamondback's aim to grow shareholder value and not just its size increases the likelihood that it could outperform Concho's stock in the coming years. That slight difference makes it the better Permian oil stock to consider buying between the two, in my opinion.

10 stocks we like better than Concho ResourcesWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Concho Resources wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of August 6, 2018

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.