Devon Energy (NYSE:DVN), one of the largest independent exploration and production companies, reported 2Q14 operating EPS of $1.40, in-line with consensus estimates of $1.40. Strong quarterly results were boosted by production growth in high-margin oil, as well as higher prices. Despite third-party gathering facility downtime, strong execution in the Eagle Ford was very encouraging. This also raises confidence in the company's ability to meet or even beat its 3Q14 Eagle Ford shale production guidance.
Transformation Largely Complete, Now Focus Is On Core Operations
Devon has taken a number of steps in recent months to high-grade its portfolio and has significantly improved its investment profile. The company has been shifting focus away from gas to oil through a number of acquisitions and divestitures. Since November last year, DVN has sold or has agreed to sell more than $5.1 billion in non-core assets. Two of the most important changes in the company's portfolio have been the $6.0 billion Eagle Ford acquisition and the significant expansion of drilling inventory in the Delaware Basin.
In a recent multi-billion dollar deal, Devon sold its gas-rich assets to Linn Energy (LINE) for $2.3 billion. DVN's transformation is largely complete now and Devon is a much stronger and focused company than it was a year ago. The company now is far more focused on high-quality liquids rich core areas in the U.S. and Canada. The Oklahoma based company has five focus areas that will help drive liquids volume to 60% of total production by the end of 2014. These focus areas are the Eagle Ford, the Permian Basin, Canadian Heavy Oil, the Anadarko Basin and the Barnett Shale.
Permian and Eagle Ford Will Be the Primary Driver of Organic Growth
The company is expected to produce 579-622 MBOE/d from its core assets in 2014, reflecting organic growth of ~7-15% with organic oil growth of >30%. The company is expected to spend $5.0-$5.4 billion in E&P spending in 2014 and most of this budget will be directed at the Eagle Ford, the Permian and Canadian assets.
Permian Basin and Eagle Ford shale will be the primary driver of this >30% oil growth in 2014 and ~20% growth in 2015. There is a significant upside potential in the Permian and Eagle Ford. The production growth targets for this year and 2015 will be driven by increased activity in the Eagle Ford and Permian as Devon ramps its rig count in the Delaware Basin and the pad drilling program in the Eagle Ford accelerates new wells to sales.
In the Permian, the focus to date has been the Bone Spring interval in the Delaware Basin, where 22 wells were brought online in the second quarter. The company also began production of two wells targeting the Delaware Sands with an average 30-day IP rate of ~1.0 MBOE/d. From the current 12 rigs operating in the Delaware Basin, the company plans to move to as many as 20 rigs by the end of 2015. The Southern Midland Wolfcamp formation is also contributing to Permian growth and Devon plans to ramp-up activity in the Northern Midland area next year. And it just spud its first Wolfcamp B well here. The company managed to increase overall production in the Permian by 25% Y/Y to 95,000 BOE/D.
Similarly Eagle Ford also holds significant upside and production from the Eagle Ford should be up 100% from where it stood when Devon closed this acquisition at the end of February. Since then, the company has identified upside potential in the Upper Eagle Ford, which appears to be prospective across most of its 82,000 net acres, and it just recently spud its first well targeting this interval in DeWitt County. Despite of temporary third-party facility downtime, Devon executed well in the Eagle Ford shale in the second quarter. The company achieved average production of 65,000 BOE/d in the Eagle Ford in 2Q, in line with previous guidance. The company managed to overcome the temporary disruptions tied to gathering systems which weighed on overall production levels by ~8,000 BOE/D.
Devon is a much different company than it was a year ago. In the last year the company has taken a number of strategic decisions to high-grade its portfolio. Devon has transformed itself into a much stronger and focused company. From its roots as a natural gas producer, Devon has shifted its focus to high-return core areas (Eagle Ford and Delaware Basin). The transformation is largely complete now and the recent asset repositioning and capital re-allocation should lead to improving results. This transformation will allow Devon to sustain growth rates in the high-single digits for several years.
Devon is trading at a discount compared to its peers. Devon has a forward price/earnings ratio of 10.9, compared to 18.7 for Anadarko Petroleum (NYSE:APC) 15.7 for EOG Resources (NYSE:EOG), 12.1 of Marathon Oil (NYSE:MRO), and 17.5 for Hess Corp. (NYSE:HES). Similarly DVN is trading at a price/cash flow of 4.7, compared to 6.8, 7.2, 5.0 and 6.7 for APC, EOG, MRO and HES, respectively.
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