- The company has experienced a handsome appreciation in share price over the past quarters.
- Devon Energy is currently going through a transition phase.
- Huge debt will lead to lower bottom lines in the coming quarters.
- Share price volatility has been a problem for Devon in the past as well.
Devon Energy Corp's (NYSE:DVN) second-quarter earnings on August 6th came with a positive surprise. Revenues substantially beat the consensus estimate. Revenues of $4.5 billion beat analysts' expectations by $800 million and increased 46% year over year. The company's reported earnings per share of $1.4were in line with analysts' estimates.
The share price has appreciated by more than 23% year to date yielding a healthy return for shareholders that was better than the industry's average of approx.17%.
However, the company is going through a transition period as it changes its two-pronged business approach to a more focused one. The oil and gas company is going through the process of divesting its major gas businesses and acquiring more oil resources for future production.
The company has sold its Canadian conventional assets to Canadian Natural Resources Limited (NYSE:CNQ) for CAD $3.125 billion Canadian dollars or approximately USD$2.8 billion. The company's retained Canadian business will consist of its thermal heavy oil, Lloyd minster, and Horn River assets.
More recently, the company entered into an agreement to finalize the sale of all of its non-core assets to Linn Energy (NASDAQ:LINE) for $2.3 billion or approximately $1.8 billion after tax. This agreement consisted of the remaining assets in Devon's divestment process and includes properties in the Rockies, onshore Gulf Coast, and Mid-Continent regions of the U.S.
"With the sale of our remaining non-core assets, the portfolio transformation that we announced late last year is now complete," said John Richels, president and chief executive officer. Moreover, the company is also in process of acquiring new assets to complete the transition. Thus, in an appreciably short period of time the company has transformed its portfolio using three main steps: the accretive Eagle Ford entry, the innovative creation of EnLink Midstream, and the sale of its non-core properties. All in all, the company has sold, on a year to date basis, assets worth more than $5 billion.
Long-term debt levels increased to $11.88 billion at the end of this quarter from $7.96 billion year to date. The debt to equity ratio increased on a quarterly basis to 57%. This will result in a considerable increase in interest expense and lower the company's bottom line.
Debt management is also particularly important for Devon in its current situation since it is pursuing its transition plans. Although the company has sold all its assets up for sale, it is still in the process of acquiring newer and more expensive assets. Therefore, high leverage will cause future borrowings to be considerably more expensive.
Although the company plans to repatriate the cash proceeds from the assets sold. The question still remains unanswered as to what primary purpose will be served with this repatriated money. Will it be used to partially service its huge debt incurred to finance its Eagle Ford acquisition? Or will it go towards purchasing more assets? The company expects net proceeds of $2.7 billion after adjusting for currency exchange and taxes associated with the sale and repatriation of the funds. It is highly critical to use this money in the best interest of shareholders.
Share price volatility has been a problem for Devon in the past as well. For instance, its price fluctuated from $93 to $58 in 2011 reflecting a decline of approximately 38% within the same year. And this is not a one-time story. The company has a trend of achieving new highs and then following with extreme lows. However, the fundamentals do not support such a low price at this time.
However, it is important to tread with caution. The recent transition phase has put the company in an extraordinary position. There are clearly two distinct paths for the company to choose. It can either choose to go towards financing newer assets or it can choose to service its debt. Both sides have their pros and cons. But it is important that investors are kept abreast of the situation at all times.
This leads me to allude to another vulnerability that the energy sector has been facing. Oil prices have been declining and this trend is expected to continue. First, the oil shale boom, currently going on in the U.S has put it ahead of Russia and even Saudi Arabia in terms of oil production; this has increased the worldwide oil production and hence supply. Secondly, amidst tensions in the Middle East, oil production hasn't decreased. What's quite strange and comical though is that it has reached a new high. Iraqi oil production currently stands at 30-year high levels. Similarly, OPEC's overall oil production rose to a new high in July.
Oil markets are also supporting this trend. Spot prices for North Sea Brent crude oil averaged $112/bbl. in June. This made it the 12th consecutive month of falling average prices. On the same note, the forecast Brent crude oil price for 2015 by STEO averages 105/bbl. (EIA report). Thus, there is enough evidence to predict that the declining trend will continue for some time.
Considering the strong run of the stock in the recent past with mounting uncertainty in the wake of the transition period and a declining trend future prediction I'd recommend those already long for some time to sell the stock and make a reasonable profit. For those who wish to know if it is the right time to purchase, I'd go against this notion for now and recommend waiting for a more suitable time.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.