Devon Energy: The Future Looks Bright

| About: Devon Energy (DVN)


Investment firms such as Zacks, Credit Suisse, and Deutsche Bank are raising their price targets on Devon Energy Corp.’s shares up to $80 indicating upside potential for the shareholders.

The company’s Eagle Ford acquisition are likely to upgrade the company’s production profile and portfolio to expand its operations in oil that hold more financial prospects for the company.

The prices of crude oil will rise due to economic recovery and infrastructure enhancements while natural gas prices will remain flat due to the shale gas boom in the U.S.

Additionally, the company has also structured itself to capitalize on the growth from the midstream operations that are also in-line with the industry trends for capital spending.

The company’s revenues are expected to rise 20% in FY 2014 and 7% in FY 2015 while its bottom-line and cash flows will also benefit from the strategic moves.

Zacks recently reiterated its neutral rating on Devon Energy Corp.'s (NYSE:DVN) shares. The firm currently has a $72.0 price target on the stock while the stock is currently trading around $67.79. The firm considered the company's audacious step to improve its position in the Eagle Ford Shale by acquiring GeoSouthern Energy for $6 billion in cash. The firm's rating reflected the concerns of the negative effects of the cyclical demand for oil, natural gas, and NGL in conjunction with volatility in prices on the company's profitability. Therefore in this article I will discuss a few factors that will affect the company's financial performance and position in the coming years.

The company is an independent energy company involved in the exploration, development, and production of oil, natural gas, and NGLs. Let us begin with a discussion on the prospects the company could capitalize on from its recent Eagle Ford acquisition.

Prospects from Eagle Ford Acquisition

According to Zacks the acquired assets in Eagle Ford are anticipated to contribute $800 million to the company's free cash flow from 2015 and add more afterwards. These cash flows will come from the rise in the company's production to be contributed by the region. The following chart shows that the company projects its production from Eagle Ford to grow 70-75 MBOED in FY 2014 up from 53 MBOED projected to be recorded in Q4 FY 2013.

Source: DVN The New Devon Presentation

The acquisition of Eagle Ford assets, comprised of 82,000 net acres situated in DeWitt and Lavaca counties in Texas from GeoSouthern Energy, has led to a favorable portfolio upgrade for the company. According to the company, Eagle Ford is a topnotch light-oil position and is delivering exceptionally well results by presenting some of the highest rate-of-return drilling prospects in North America. To strengthen its position in the reserve rich Eagle Ford shale Devon will further invest $1.1 billion in the region in FY 2014. The company has plans to drill 200 wells in this region in FY 2014 to boost the reserves of the company.

The company is investing more in oil operations and Eagle Ford as the company has realized its operating environment contains depressed North American gas prices in contrast to more robust prices of oil and NGLs. The International Energy Agency recently raised its 2014 oil demand forecast as it sees U.S. consumption recovering in 2014. The following chart shows the EIU's forecast of WTI prices and indicates that the WTI crude oil prices will rise to $100.6/ barrel in 2014.

Source: Knoema

Among NGLs the majority of the company's natural gas is comprised of ethane. This component of the natural gas is used as petrochemical feedstock. The overall economic recovery in the U.S. will trigger a rise in the manufacturing of plastic products and thus demand for ethane will improve. Previously, the market was oversupplied with ethane while the demand was low due to the economic slowdown that adversely impacted the prices of this natural resource.

On the other hand, the following chart projects a slight decline in Henry Hub Natural Gas Price for the coming periods due to the shale gas boom. This has already upset many of the U.S. natural gas players and that is why the U.S. government is considering exporting this natural resource to other countries such as Mexico.

Source: EIA

These outlooks of crude oil, NGL, and overall natural gas prices for the coming years indicate where the potential lies for the company. The company's production profile in FY 2013 was comprised of approximately 55% natural gas, 25% oil, and 20% natural gas liquids. With the support from the investment in Eagle Ford the company expects oil to increase its stake in the company's production profile to 30% in FY 2014.

In addition to diversification the company's acquisition of GeoSouthern Energy's assets in the Eagle Ford shale serve as a replacement for the company's divested businesses. The company's divestitures during the past year include the sale of the company's natural gas assets in Canada and six natural gas plants for about $3 billion to Canadian Natural Resources. This helped the company's balance sheet after its huge purchase in the Eagle Ford late last year.

According to Goldman Sachs, the conclusion of Devon's restructuring will make the company well-positioned to grow its oil production considerably. Goldman Sachs projects Devon will grow its oil production by 50% to 330,000 barrels/day by 2016. That increase in oil production could help Devon to moderate its exposure to oversupplied natural gas markets.

In addition to diversification in its production profile the company is also putting efforts into diversifying its operations. The company is categorized as an oil and gas exploration and production company but now the company is looking forward to capitalizing on prospects from its diversification to midstream industry.

More Focus on Midstream Growth and Prospects

Devon is attentive to its favorable production profile and its midstream operations. Devon combined and spun out all of its U.S. midstream assets in a partnership with Crosstex Energy Inc. (XTEX) and formed a new midstream MLP business, EnLink Midstream Partners LP (NYSE:ENLK) and general partner security as Enlink Midstream LLC (NYSE:ENLC). Devon will have substantial power regarding the operation of the new business through its majority ownership interest in both the general partner and the MLP and majority representation on both boards. The stress on the development of midstream assets by the company seems to be a smart move considering the oil and natural gas production boom in the U.S. shale plays.

With backing of Devon Crosstex has tremendous opportunities in the Utica shale in Ohio. This type of midstream company with the ability to amalgamate and handle condensate products could do very well with the least amount of capital investment. No other company has a proficient plan composed to cater to customer specs and to gain from potential transportation savings.

Other Ratings and My Take

Various other analysts have also recently evaluated Devon. Analysts at BMO Capital Markets initiated coverage on shares of Devon Energy Corp in a research note on April 9th 2014. They set an "outperform" rating on the company's stock with a price target of $80.00. Credit Suisse has also reaffirmed its "positive" rating on shares of Devon Energy Corp in a research note on April 3rd 2014 raising the company's stock price target from $76 to $80. Lastly, analysts at Deutsche Bank also increased their price target on shares of Devon Energy Corp from $73.00 to $79.00 in a research note issued on April 1st 2014. Thirteen analysts have given the stock a hold rating and thirteen have assigned a buy rating to the stock allowing the company to reach a consensus rating of "buy" and a consensus target price of $74.16.

The company's revenues are expected to rise by 20% in FY 2014 and 7% in FY 2015. After earning an EPS of $4.26 in FY 2013 Devon is expected to earn an EPS of $5.58 in FY 2014 and $6.34 in FY 2015.

The company's Eagle Ford acquisition is likely to create enormous growth prospects for the company's oil operations and will diversify the company's production profile that currently relies heavily on natural gas. While the natural gas prices are predicted to remain low in the U.S. due to the shale gas boom the enhancement of the oil and gas infrastructure and recovery in oil consumption in the U.S. will support the crude oil prices and help them to rise in the coming periods. Moreover, Devon has also structured itself to avail the growing opportunities from oil and gas midstream industry that is also in-line with the industry trend for capital investments. These factors have made the company's stock price recover and it has slightly increased in comparison to the SIG Oil Exploration & Production Index as shown in the following chart. The company's share price underperformed the SIG Oil Exploration & Production Index during most of the previous year.

Source: Ycharts

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.