Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Shares of Devon Energy (DVN) have seen some choppy trading conditions over the past week. The plagued independent energy company focused on the exploration, development and production of oil and natural gas reported its first quarter results before the opening bell on Wednesday.

Shares have gained some 8% over the past week, based on the fact that the company is moving its production towards higher yielding liquids. The positive general market sentiment has been helpful for shares as well.

First Quarter Results

Devon Energy generated first quarter revenues of $1.97 billion, down 21.0% on the year before. Excluding the negative $320 million contribution from derivative contracts, revenues came in at $2.29 billion, down just 2.5% on the year before. Adjusted revenues, which exclude the impact of derivative contracts, came in line with consensus estimates of $2.28 billion.

The company reported a net loss of $1.34 billion entirely attributable to a $1.91 billion impairment charge, predominantly related to lower liquids pricing. Adjusted earnings came in at $270 million, or $0.66 per diluted share, which compares to net earnings of $393 million, or $0.97 per share last year. Adjusted earnings beat consensus estimates of $0.55 per share.

CEO Jonh Richels commented on the first quarter performance,"Our continued focus on oil production growth is successfully transitioning Devon's production mix to a higher oil weighting, as evidenced by our first-quarter results. Oil and liquids production, our highest margin product, now accounts for 41 percent of our total production. Driven by our success in the Permian, we are on track to grow our US oil production by almost 40 percent in 2013."

A Look Into The Numbers

Devon reported solid production numbers for the quarter. Oil production averaged 162,000 barrels per day which is up 14% on the year before, and up 8% on the previous quarter.

Total production of oil-equivalent came in at 687,000 barrels, ahead of the company's guidance, but down 2% on the year before as natural gas production fell by 8.8%.

Operating pre-tax costs came in at $898 million, or $14.54 per barrel of oil equivalent. Costs per unit were up 5% on the year despite management's cost control efforts as the shift towards oil production results in higher operating expenses. Impressive is that cost per unit fell by 4% compared to the fourth quarter of 2012.

The marketing and midstream assets generated operating profits of $125 million on the back of a solid execution.

Valuation

Devon Energy ended its first quarter with $6.5 billion in cash and short term investments. The firm operates with $12.1 billion in short and long term debt, for a net debt position of around $5.6 billion.

For the year of 2012, Devon generated revenues of $9.5 billion on which the company reported a net loss of $206 million after taking $2.1 billion in impairment and restructuring charges.

Trading around $56 per share, the market values the equity of the firm around $23 billion. This values the company at around 2.4 times annual revenues and around 15 times adjusted net income for 2012.

Devon Energy currently pays out a quarterly dividend of $0.22 per share, for an annual dividend yield of 1.6%.

Some Historical Perspective

Despite the turmoil in recent years, investors in Devon Energy have seen some decent long term returns. Shares advanced from $25 in 2003 to peak around $120 in 2008 just before the economic crisis came along and hit leveraged natural gas energy companies hard.

Shares corrected towards $40 per share in 2009 in the wake of the financial crisis but swiftly recovered to $90 in 2011. From that point in time shares have given up another 40% of their value, currently exchanging hands in the mid-fifties.

Between 2009 and 2012, Devon has grown its annual revenues by a cumulative 20% to $9.5 billion. The company took a massive $6.5 billion charge in 2009 and another $2.1 billion charge in 2012, but was solidly profitable in each of those years excluding the write-downs.

Investment Thesis

Obviously the bad news in the latest report was the somewhat surprising impairment charge. Devon took a $1.9 billion charge which seemed counterintuitive, as the company readily admits, as gas prices were relatively strong during the quarter. Today's charges are mostly related to weakness in NGL prices and Canadian crude prices which both have seen weakness on the year. Recently the discount of Canadian crude prices widened to just 50% of WTI benchmark prices.

So far the bad news. Better news includes the strong liquids production, the cash repatriation, the possibility of a master limited partnership and a recent dividend hike.

Oil and liquids production was strong during the quarter with oil-equivalent production of 162,000 barrels, ahead of the company's own guidance. Devon guided for second quarter production of 163,000 to 173,000 barrels, up 3.1% on the quarter at the midpoint of the guidance.

The company furthermore surprised the market by indicating that it could repatriate roughly $2 billion of foreign cash with a tax impact in the mid-single digits, after assessing its net operating losses from last year. Note that the company holds some 94% of its $6.5 billion in cash balances abroad, and the move gives it flexibility to fund US and Canadian operations.

Devon is furthermore investigating the possibilities to set up a tax-advantaged MLP. The company decides upon the set-up of such a partnership by the end of the quarter, in its attempt to further unlock value for shareholders.

Despite the write downs, the company recently announced a 10% dividend hike as the overall balance sheet remains solid enough. The reduction in leverage and the move from natural gas production towards liquids has boosted the operating performance of the company. Despite the massive debt position, the balance sheet liquidity and solid foundation of liquids production provide a cushion for possible harsh times. The opportunities in the Rockies and the Mississippi Lime, combined with the vast natural gas acreage portfolio, gives the company a lot of operating leverage if energy prices, and natural gas prices in particular, continue their recovery.

While I applaud the company's long term potential, I remain in the sidelines for now. Operating profitability is too low in relationship to the current valuation in light of today's levels oil and natural gas prices.

Source: Devon Energy: Increased Oil Production Outweighs New Impairment Charge