Devon: Quietly Creating Shareholder Value

 |  Includes: BP, CVX, DVN, XOM, XTO
by: Devon Dolan

There is the old adage “it's better to be lucky than smart.” Devon Energy (NYSE:DVN) strikes me as a company that does well at being both. The company managed to exit and monetize its offshore oil business just prior to the BP disaster and continues to monetize assets and pay down debt (1.7 billion YTD) strengthening its cash position, and buying back company stock. To put things in perspective, Devon has approximately 30 billion in market cap and expects to receive somewhere between 8 to 8.5 billion after tax proceeds once all deals are closed. (They have currently closed on 4.6 billion in after tax proceeds of all planned divestures.) The assets sold represent about 10% of Devon’s production, yet represent over 20% of the company’s enterprise value. Apply that metric broadly across all of Devon’s assets and you can see where I’m going with this. The company is also growing production, but that is par for the course so let’s take it further:

The company is buying back its stock. To date it has purchased 3% of its outstanding shares; 7.6 million shares at approximately 65.13 a share and another 11.9 million shares at approximately 63.94. Traders – alert yourselves to this price floor. The total buy back seeks to purchase 3.5 billion dollars in shares over the next 12-18 months, ultimately reducing share count by 12%.

They have exited the offshore oil business. Going forward, many would agree offshore drilling is going to be a nightmare in terms of rising costs, higher risk profiles, and burdening regulatory oversight. Consider that any slip in the waters risks a company’s franchise, and any management team worth their salt will be placing a premium on that risk. With the proceeds from those divestitures, Devon offers itself and its shareholders optionality - they can cherry pick deals at their leisure. For example - they recently announced a 50% working interest in BP’s Kirby oil sands play for 500 million dollars. This play is geographically adjacent to Devon’s existing Jackfish play. A relatively small deal, but an example of acquiring good assets with only incremental capital expenditure as nearby infrastructure is already in place. I suspect you will see more of this type of synergistic asset acquisition. One could add that from a secular perspective, future production limitations from the offshore oil business need to be replaced, and oil sands assets represent a primary source of replacement. Devon is active in sands plays.

Devon trades at 4.1X 2011E EV/EBITDA versus a 4.5X average for peers. Yet, should in my opinion, trade at a significant premium to peers due to its outstanding management team. Additionally, the market's ongoing hatred for Natural Gas assets and misguided certainty that Natural Gas prices will remain low forever, places very little value on Devon’s dominating position in North American Natural Gas plays. Even after XOM purchased XTO and Chevron (NYSE:CVX) quietly acquires gas acreage, the market remains blind to the longer term picture. Not to mention that the perception of our vast and supposedly never ending supply of gas fails to account for the rapid depletion of well of life (supply) – or the fact that our government is actually considering legislation to subsidize the conversion of 18 wheelers from diesel to natural gas (demand). As a pure commodity, Natural Gas is perhaps one of the most undervalued assets across the commodity spectrum – but that is another article. The point is simply that when Natural Gas prices rise (yes I said when) Devon will be in an ideal position to profit. Again, embedded optionality. In the meantime - they continue to execute and create value for their shareholders despite sub optimal gas prices – something most other E&P companies are incapable of achieving.

I would not be surprised to see this company purchased outright somewhere between 80-90 dollars per share. The world class assets are de-risked, the balance sheet is solid, and the company’s former CEO (Now Chairmen) is perhaps approaching the twilight of his stellar career.

Disclosure: No positions