Because of supply and demand dynamics, natural gas prices continue to be volatile. Speaking of natural gas prices, companies in the E&P industry expect that in 2014, natural gas prices will remain relatively flat compared to 2013. However, crude oil prices were fairly stable throughout 2013. The production of oil continues to be more profitable than natural gas, and consequently, companies operating in this industry have been shifting their focus to oil production. To make a change toward liquid plays, companies are investing billions to acquire oil producing assets while disposing of non-core assets. The change in strategy has worked for companies in 2013 as liquid plays offer much better volume and margins.
In this article, I picked Devon Energy (NYSE:DVN) to see how it is operating in the changing circumstances when compared to ConocoPhillips (NYSE:COP) and Occidental Petroleum (NYSE:OXY). Also, I will determine which company offers better returns for investors in this rapidly-changing business environment. This article will focus on their ability to sustain returns by looking at their business plans, financial situations, and future prospects. That way, I can point out whether either of these stocks is a buy or hold.
Where does Devon stand?
DVN's strategy is quite straight forward. The company is looking to expand high margin liquid production and to attain liquid plays at 60% of its overall production mix in this year. DVN's oil products achieved 21% growth year after year from the go-forward asset base by the end of latest quarter. To do that, over the past few quarters, DVN has been heavily investing to capture oil and natural gas liquid assets while disposing of non-core assets, which offer low margins and depressed profits.
It recently closed Eagle Ford acquisition which has placed it in the heart of light oil core area. It has recently announced bolt-on [ph] acreage acquisition in Cana, which will bring about 5,800 barrels of oil equivalent per day (37% liquids) with the proved reserves of around 23 million barrels of oil equivalent. The company went from Canadian conventional gas and completed EnLink Midstream combination. Its recent move has taken DVN's asset base to most development plays in the Permian Basin, Canadian Oil Sands, the Eagle Ford, the Barnett Shale, and the Anadarko Basin liquids-rich gas plays. Furthermore, from these assets, the company is looking to generate 20% organic oil production growth in 2015. Its Jackfish 3 facility in Canada will bring multi-year oil production growth from its thermal oil business. All these developments set the company in a very strong position to ensure future growth.
With the recent investments in liquid play, the company earned $557 million in the first quarter of 2014, representing an increase of 103% over the past year quarter. Strong growth in earnings led the company to generate 41% increase in its operating cash flows. It is looking to invest around $5 billion in its go-forward assets this year, and its free cash flows are providing full support for these investments. DVN is likely to increase its operating cash flows with the growth in liquid production. Its recent dividend increase also illustrates management's confidence in their cash generating potential.
Where Do other Players Stand?
ConocoPhillips is the globe's largest E&P company. COP also shifted its focus on liquid plays while reducing investments on natural gas. To do that, it has invested around $15 billion in the past year and $16.7 billion in this year. Its objective is to produce 3-5% growth in production and margins. In the last year, its liquid production was standing at around 56%, and this year, the company is looking to accelerate growth from liquid plays as they are offering better margins. Its recent three projects and investments in oil sands in Canada and the Lower 48 will likely to add more liquid production. COP is right on its objective of 3-5% growth in production. In the past quarter, it showed 3% growth in production to 1,530 MBOED. With the shift towards liquid plays and some increase in gas prices, its cash generating potential grew stronger, which not only provides cover to capital investments but also provides complete cover to dividend payments. In the past quarter, it generated operating cash flows of $6.2 billion, capital investments were at $4 billion, and dividend payments were at $0.9 billion.
Occidental Petroleum's business strategy is similar to COP's and DVN's. It is also moving more towards liquid production. In 2013, its domestic oil production grew by 11,000 barrels per day, reserves replacement ratio was at 195%, and in the latest quarter, the domestic oil production grew by 10000 barrels per day. The company's main focus is toward growing domestic liquid production due to higher growth and volumes in liquid plays. The California, Permian basin, and international regions like Qatar and Oman are key places for OXY's investments and growth opportunities. Its investment in projects like the BridgeTex Pipeline, the New Johnsonville Chlor-alkali plant, and the Al Hosn Gas Project are expected to boost cash flow.
DVN is heading in the right direction, and the company has set strong footprints for future growth with its recent investments both in North America and Canada. With the transformation in asset portfolio, DVN started generating healthy profits and a massive growth in cash flows. Going forward, I am expecting much more growth in its earnings and cash flows as the company is looking to accelerate its liquid growth production, and recent portfolio adjustments will ensure that the company will achieve higher growth. On the other hand, COP and OXY are also following similar business plans. Both companies have made big changes in their portfolios and are on track to generate healthy profits.
Though DVN has made considerable increases in dividends around 50% since 2011, it still looks more like a value stock. Its dividend yield is much lower what than COP and OXY offer. However, with a strong portfolio management and healthy financial results, its stock is gaining momentum. Year to date, DVN's stock gained 18.17% while COP is up by 11% and OXY only up by 1.49%. Continued surge in price make DVN stock a bit expensive over the other two players. But, I think buying DVN on dips might be a good idea as I believe it has established very strong footprints for future growth with recent developments in its portfolio.
On the other hand, COP and OXY are still in the buying zone as both companies are trading at attractive multiples with healthy dividend yields. Both companies are generating strong cash flows, which are covering their dividend payments and capital investments. Both of these companies look like perfect stock for defensive investors with the ability to offer consistently increasing dividends and steady growth in price appreciation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.