3 Reasons The Rally In Devon Energy May Continue

Jun.25.14 | About: Devon Energy (DVN)

Summary

Devon Energy has raced into the upper $70s recently but could be headed to at least $85 in the coming months.

Devon's focus on increased oil production thanks to its recent Eagle Ford purchase should help drive revenue and earnings growth going forward.

Devon could find itself tripling its oil production in the Eagle Ford by 2017.

Devon Energy (NYSE:DVN) spent January and much of February flat-lining in the $60 area. Then they beat earnings estimates for Q4 2013, announced that they were selling Canadian assets for around $2.8 billion and it's been off to the races ever since. The company's transition to natural gas liquids and oil production is paying dividends and the stock is now in the upper $70s.

Devon stock is no longer the value it was at $60 as it is at $78 but that doesn't mean that we've seen the end of this rally. Management has made the right moves to ensure that the company is poised to continue growing revenue and earnings. If Devon is able to deliver on those expectations the rise in Devon's stock price might not be over yet.

While the move in Devon shares in 2014 so far has been impressive, here are a few reasons to think that this rally might have further to go.

The stock appears to be reasonably valued and may still be undervalued

Even after its recent run, Devon's forward P/E is still just 12.4. The broader market is looking at a P/E ratio of around 17. Devon's valuation also compares favorably to fellow energy companies like Anadarko Petroleum (NYSE:APC) (21.1) and Chesapeake Energy (NYSE:CHK) (13.3).

Another metric that would provide a good comparison is enterprise value/EBITDA. Devon is currently sitting at a ratio of 5.62 which is comparable to Chesapeake's 5.67 but well below Anadarko's 7.01.

These numbers suggest that Devon has room to rise should it be valued at the level of some of its peers. A valuation somewhere between Chesapeake and Anadarko would push Devon's stock price to the $85 range - a roughly 10% premium to Devon's recent stock price.

Expanded production from the Eagle Ford purchase

Devon's $6 billion Eagle Ford purchase may end up looking like a bargain when all is said and done. The 82,000 acres that the company acquired is estimated to help drive up oil production by around 20% this year compared to 2013. The company estimates that its current Eagle Ford production of around 53,000 barrels a day could nearly triple to around 145,000 barrels a day by 2017.

That production has already helped fuel revenue growth that is expected to hit $14.2 billion in 2014 - a figure that would represent a rise of 37% over 2013 revenue. Earnings are expected to take a similar trajectory expecting to improve 35% in 2014 over 2013's results. Absent a negative move in crude prices, there's a lot of potential in Devon's future revenue growth.

Divesting itself of non-core assets and focusing on North America

I wrote about this back in April when Devon announced that they were selling $2.7 billion in Canadian natural gas assets in part to help pay for the Eagle Ford purchase. It was a logical move that not only helped defray the cost of the acreage in the Eagle Ford but also rid itself of a non-core natural gas asset in favor of a U.S.-based oil producing asset.

Devon's decision to focus on oil production in North America has already begun paying dividends and should continue paying them as crude oil production continues to increase over the next several years.

Conclusion

Devon Energy shareholders were treading water in 2013 waiting for the company to provide a catalyst for the stock's price to move higher. The expansion in Eagle Ford and the focus on North America seem to be it and the shares have been rallying.

Analysts like Devon's bright future as well as several have upgraded or raised their price targets on the stock. Examples include Wells Fargo raising its price target to $90 recently and Bank of America appearing even more optimistic calling for a $100 price target.

Given the stock's attractive valuation along with increased crude production driving revenues and earnings higher, we may not have seen the peak yet.

Disclosure: The author is long DVN. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.