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Summary

  • Devon Energy has been a strong performer in 2014 after underperforming in 2013.
  • The company continues to transform into a fast growing oil play.
  • Given its growth trajectory, the shares are still undervalued.

Devon Energy (NYSE:DVN) is a case study on why it pays to be patient with long-term value stories that you believe in. I picked up these cheap shares in the fourth quarter of 2013. I thought it could be the next Hess Corp. (NYSE:HES), which provided huge gains for shareholders, including myself in 2013.

Unfortunately, the stock did not do much in 2013 while most equities staged significant rallies. This has changed in 2014, and the stock has been a very strong performer in the New Year, with shares up better than 10% so far this year. The stock recently hit a 52 week high.

The company has spent the last two years changing from a predominantly natural gas exploration company to a crude oil and liquids production concern. The company is executing this plan beautifully lately and has begun to be rewarded for this transformation in the market. I believe we are in the early innings of this move upward, and Devon is my favorite play in the energy mid-majors for 2014.

Recent Moves:

The company recently agreed to sell its natural gas assets in Canada and six natural gas plants for ~$3B to Canadian Natural Resources (NYSE:CNQ). This will help its balance sheet after the company made a big purchase in the Eagle Ford late last year. It also will boost again the overall amount of production coming from oil. The company also recently spun out its midstream assets in a partnership with Crosstex Energy (XTEX). This makes Devon a pure E&P play deserving of a higher multiple.

Valuation:

The stock goes for ~10.5x FY2015's projected EPS. It is cheaper on an operating cash flow basis where it goes for around 5x operating cash flow. The shares also provide 1.4% after just bumping its dividend ~9% earlier in the year. The company has also beat bottom line expectations each of the last six quarters.

Outlook:

Devon has one of the strongest earnings trajectories of any of the mid-majors. After making ~$4.25 a share in FY2013, consensus calls for Devon to make ~$5.70 in FY2014 and ~$6.30 a share in FY2015. Even though Devon gets most of its production from Oil & Liquids these days, the highest natural gas prices in years certainly is a nice tailwind.

I would look for Devon to continue to execute against its strategic plan. It made a $6B purchase last year to acquire additional assets in the fast-growing and oily Eagle Ford. The company should have years of robust production growth ahead of it. Investors are just starting to notice the company's strides and growth. I think this continues throughout 2014. BUY

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.

Source: Devon Energy: Why The Shares Are Rallying In 2014