Divestment Will Unlock Greater Value For Devon

Jul.13.14 | About: Devon Energy (DVN)


Devon recently announced that it would sell its non-core assets in the US for approximately $2.3 billion.

The deal will not only allow the company to reduce the debt burden but will also help it to focus on the core oil producing assets.

In addition, the newly-balanced portfolio comprised of liquid-based assets is well positioned to deliver strong production growth.

Devon Energy (NYSE:DVN) recently announced it would sell its non-core US oil and gas properties to Linn Energy for $2.3 billion. The company will then be divesting its properties in the Rockies, onshore Gulf Coast, and Mid-continent regions. It also sold its Canadian non-core assets later in April 2014.

With the selling of its gas based assets, the company can now clearly focus on becoming a company that is based predominantly on crude oil drilling rather than a company with a balanced portfolio of oil and gas assets. The move is considered to be strategic in nature, allowing Devon to rely more on liquid production. In light of the recent divestment, it shall be desirable to discuss the company's future growth prospects.

Creating a More Balanced Portfolio of Oil and Gas Properties

Devon and Linn Energy have recently reached an agreement that allowed Linn Energy to acquire oil and gas properties of Devon Energy for a payment of $2.3 billion. The deal is expected to close by the end of 3Q 2014.

In addition, the company recently sold its non-core assets in Canada for C$3.125 billion or US$2.7 billion. The divestment included 170 million barrels of oil equivalent of proved reserves. These assets are capable of producing 357 million cubic feet per day of natural gas production. The company expects to use the sale proceeds to pay off the borrowings that were recently used to fund the acquisition of a portion in the Eagle Ford shale.

These steps reflect the management's strategy to transform its portfolio of assets into a liquid-based portfolio. By focusing on oil production growth, the company can expect improved margins. In addition, with the sale of these assets, the production of liquids is expected to be more than 60% of the total production while the multi year oil production growth is expected to be more than 20%. As it has also been observed by CEO John Rachel, "we transformed our portfolio through three steps - the accretive Eagle Ford entry, the innovative creation of EnLink Midstream, and the sale of our non core properties".

Moreover, as a result of the divestment, Devon will be able to pay off approximately $4 billion of its debt by the end of 2014. The reduced debt will strengthen the investment grade credit ratings for the company and pave the way for long-term growth prospects.

Production Growth

While the company has successfully gotten rid of assets that could potentially become a liability in the long term it is also on track to delivering strong production growth. In doing so, Devon has allocated nearly $5.0 - $5.4 billion in capital budget. The capital budget is strategically allocated:28% is allocated to the Permian Basin and 21% is allocated to the Eagle Ford shale.

The capital budget is concentrated on developing oil plays, particularly in the US. Going forward, these assets are expected to deliver strong growth of more than 70% from the current US oil production of 73 million barrels of oil equivalent per day to the range of 124 - 136 MBOPD.

Source: Investor Presentation

With the strong acreage position in the Permian Basin, Eagle Ford and Jackfish development, the company is expected to deliver 30 percent growth in total oil production make the total production in the range of 198 - 216 million barrels of oil equivalent per day. The production growth is shown in the figure below.

Source: Investor Presentation

Concluding Remarks

The acquisition of the oil and gas properties of Devon Energy by Linn Energy is expected to be positive for both companies as it strengthens the long-term business strategies of both companies. The acquisition will help Devon to focus more on the core oil producing assets creating a balanced portfolio of oil and gas assets.

In addition, the company owns acreage positions in lucrative shale developments and is well positioned to deliver strong production growth. Currently, the company has been trading at a forward P/E of 12.05 and also at a dividend yield of 1.23%. Given the above mentioned long term growth prospects, I do not believe that the company deserves to be traded at such low multiples and that the market should correct this mistake sooner rather than later. Put simply, Devon Energy is an attractive investment opportunity, supported by healthy margins, production growth, and an attractive valuation. Moreover, the company recently reduced its debt position which will further improve its investment rating and make it a less risky investment.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.