Devon Energy: More Upside Potential Is Ahead

Aug.13.14 | About: Devon Energy (DVN)

Summary

Exploration & Production industry is moving towards oil and liquid plays.

Devon’s smart business strategy and efficient management sets it in a very strong position.

Its significant portfolio transformation and move towards liquid plays is started to bear fruits.

Devon is a good stock buy.

Devon Energy (NYSE:DVN) is one of the best companies operating in the Exploration & Production industry. Due to the volatility in gas prices, most of the companies operating in this industry moved their focus towards oil and liquid plays in search of better margins. Devon is one of the companies that have strongly pursued this objective so as to go forward with the market trends. The company has made significant transformations concerning oil and liquid plays in the past few quarters. Therefore, Devon is expecting its liquid and oil production to provide for 60% of total production by the end of this year.

In order to do that, Devon has made significant changes in its portfolio such as including the EnLink transaction, sale of non-core properties and the Eagle Ford acquisition. Recently, the company has announced the sale of around $2.3 billion of non-core assets. In the past few quarters, it has sold around $5 billion dollars' worth of non-core assets. Most of these non-core assets were providing natural gas to the company. Devon has used these proceeds to bring down its debt level and support its growth activities. I believe this huge transformation will allow the company to generate better returns per share for the investors.

Coming hand in hand with the changes in portfolio, Devon now has development projects in most of the attractive basins which are offering low risk and high return. Its portfolio consists of world-class oil development plays in the Eagle Ford, the Permian Basin and the Canadian oil sands. Moreover, Devon has two of the best liquids-rich gas areas, the Anadarko Basin and the Barnett Shale. Anadarko basin has 45% liquids and the Barnett Shale has around 30% liquids production. The company also has two emerging oil plays and has a majority stake in the EnLink Midstream.

The advantage that comes with having this portfolio in place is that Devon becomes well set to generate higher levels of oil and liquid production. At the end of latest quarter, the company has generated 34% growth in oil production on a year to year basis. Mainly, it has been led by its operations in the Eagle Ford and the Permian basin. Its concentration on oil and liquid assets increased the company's oil revenue by 42% compared to the past year quarter. The strong growth in oil and liquid production has increased its pre-tax cash margin by 40%. Going forward, the company looks to spend 80% of its capital budget on its core assets and oil development activities.

The company's strategy is generating a strong financial performance. In the latest quarter, the company has generated a 47% growth in operating cash flows compared to the past year quarter. Furthermore, Devon is expecting very strong results in the second half of the year. The company is also expecting a 20% organic growth in production and a mid digit growth in revenues. Its cash position will also expand as liquid and oil plays are offering healthy margins and better cash flows. Recently, the company showed its confidence on its cash position by increasing the quarterly dividend to $0.24/share.

Prior to making any conclusion, we must look at the potential risks. At the moment, exploration and production companies have the momentum with their shift towards liquid and oil plays while maintaining a limited focus on gas. Devon has made significant changes in its portfolio which has put it in a strong position to take advantage of the high margins and cash flows that these oil and liquid plays are offering. The company still anticipates strong organic growth in its liquid production and strong growth in earnings in the 2015. On the other hand, the company has no risk of liquidity because it has been generating massive cash flows which are completely covering its capital requirements and dividend payments. Looking into the future, the company's cash generating potential will be strengthened by the move in its business strategy. In addition to that, the proceeds received from the sale of non-core assets have strengthened its balance sheet.

In Conclusion

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The chart displayed above tells it all about the investors' confidence in Devon's business strategy and the strong results that they have been generating. Devon's share price started gaining since the company announced its last year's financial results. This also happened because of the outcomes of the strategy which it started to implement in the final quarter of last year. As a result, Devon's share price increased by almost 18% since the start of 2014. At the moment, Devon is trading in the buying range based on price to earnings ratio of 18.6. I believe the existing market correction offers an attractive opportunity for investors to pick Devon's share because the company has very strong days ahead.

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.