- Devon's decision to sell Canadian natural gas assets to pay for the Eagle Ford acreage from GeoSouthern Energy is a savvy management move.
- The Canadian asset sale continues Devon's transformation from a natural gas focused company to one that expands its oil production business.
- Despite its growth focus, the company remains undervalued relative to peers and could very well be headed to $80.
Five years ago, Devon Energy (NYSE:DVN) was known primarily as a natural gas producer. The company took a hit as natural gas prices tumbled but since then the company has diversified its operations and is slowly transforming itself into an energy company that's much better positioned for the future. Devon's recent Canadian asset sale is a shining example of that and the stock price is finally starting to reflect these changes.
In the beginning of April, Devon officially completed the sale of some of its natural gas-focused assets in Canada to Canadian Natural Resources (NYSE:CNQ) and expects to net around $2.7 billion. The transaction is Devon's latest move to divest itself of its non-core assets and properties and comes on the heels of its $6 billion purchase of assets and properties in the Eagle Ford shale from GeoSouthern Energy.
Devon made the Eagle Ford purchase almost entirely in cash and debt and will use the proceeds from the Canadian asset sale to pay off the debt incurred in the Eagle Ford acquisition. In just two transactions, Devon transformed non-core natural gas assets in Canada into core oil producing assets in an area of the country that could ultimately be one of the largest oil fields in the world. It's a savvy move that rapidly broadens Devon's energy exposure to higher margin oil.
Here's another reason why the transaction is important. By using cash, the company already had on hand to make the Eagle Ford purchase, Devon turned a zero earning asset into an asset that could potentially yield significant returns if the company is able to pull to the surface the amount of oil it expects to. Considering that the Eagle Ford acreage is expected to nearly triple its current daily output by 2017, these moves position Devon very well for the next several years.
And the street seems to like what it sees. After bouncing around for most of 2013, the stock price is finally showing what might be a meaningful sustained breakout since it hit the 70s back in early 2012. Twice in the last six months the stock price hit resistance at $65 only to retreat. A couple weeks ago when the stock hit $65 for a third time, it powered through the glass ceiling almost reaching $70 intraday.
Revenue and earnings forecasts suggest that Devon's stock has solid fundamental support and the current run might have legs. Devon's beaten earnings estimates for the last several quarters. Revenues are expected to grow 20% in 2014 and another 7% in 2015. After reporting 2013 earnings per share of $4.26, Devon is expected to earn $5.58 per share in 2014 and $6.34 in 2015. The stock carries a forward P/E ratio of under 11 and its PEG ratio of 1.62 sits well below both the industry and S&P 500 ratios.
Considering the Eagle Ford potential coupled with management's ability to transform the company's asset composition, this is clearly a company with solid growth potential with value characteristics.
Devon's management team has demonstrated that it knows what it wants the company to be going forward and that's a company that's shifting its focus away from natural gas and towards producing higher margin oil. The Eagle Ford purchase could ultimately end up paying huge dividends as production continues to ramp up. I think this is a management team that's made the right moves lately.
If Devon hits its 2015 earnings per share target at a multiple of just 12, we're looking at a price of about $76 - roughly 12% above the stock's recent price. It doesn't seem like an unreasonable target given Devon's recent merger with Crosstex Energy, its increased presence in Eagle Ford and its transition away from natural gas to oil. Given the positive catalysts and the company's history of beating estimates, I could easily see earnings coming in above expectations. A multiple expansion even a little bit to 13-14 would be a best case scenario.
Near term, I think this stock is heading to $75 and, given the right performance, could see $80.
Disclosure: I am long DVN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.