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Jim Cramer said on August 1st that Devon Energy Corporation (DVN) is a premier oil and gas player, and a growth stock that is not liked by most traders on Wall Street. He also said that the company was aggressively switching from natural gas to oil production, and had signed some major joint ventures.

We are in agreement with Cramer, and as mentioned in our reports, the links to which are given below, we briefly expressed our preference for the stock due to its production mix, which is tilted towards natural gas, and we concluded that the company would be among the prime beneficiaries of natural gas price reversals. Following the views expressed by Jim Cramer, we have decided to do an in-depth analysis of the stock.

  1. Natural Gas At Yearly Highs, Which Stocks To Buy?
  2. How To Play A Rebound In Natural Gas Prices.

Earnings Review

Devon Energy Corporation is an independent energy company involved in the exploration, drilling and production of natural gas, oil and natural gas liquids (NGL). DVN is also involved in the production of oil and natural gas from shale and coal formations, and in the production of oil from oil sands in Canada.

The company reported an EPS of $0.55 for the second quarter of 2012, showing a YoY decline of 68%. The decline in earnings was due to the decreased prices of natural gas, oil and natural gas liquids in the second quarter of 2012, as compared to the prices in the same period the previous year. EPS for the quarter also missed consensus estimates of $0.81, showing a deviation of 31.7%.

DVN's daily production reached 678.9 million barrels of oil equivalent (MBOE) for 2Q2012, increasing by 3% from 660.1 MBOE in the same period last year, which is primarily due to oil production increasing by 26%, natural gas liquids production remaining almost flat, while daily natural gas production decreasing by 3%.

Marketing and midstream operating profit was $68 million for 2Q2012, showing a decline of 54% compared to an operating profit of $148 million in the same period last year. The decline in the operating profit was due to downtime related to a planned expansion at a fractionator's facility at the Gulf Coast, and lower prices of natural gas and natural gas liquids.

 

Quarter Ended June 30

Average Daily Production:

2012

2011

Natural Gas (MMcf)

  

United States

2,050.2

2,028.7

Canada

519.1

612.3

Total Natural Gas

2,569.3

2,641

Oil (MBbls)

  

United States

56.1

46.5

Canada

92.5

71.9

Total Oil

148.6

118.4

Natural Gas Liquids (MBbls)

  

United States

90

91.8

Canada

12

9.8

Total Natural Gas Liquids

102

101.6

Oil Equivalent (MBoe)

  

United States

487.9

476.3

Canada

191

183.8

Total Oil Equivalent

678.9

660.1

The company's revenue declined 26% to reach $1.6 billion for the second quarter of 2012, as compared to the previous year's revenues. This decline in revenues is due to the lower realized prices of oil, natural gas and natural gas liquids, which more than offset the effect of the production increase. The cash settlement is due to the price hedging done by the company through derivatives to mitigate its commodity price risk.

REALIZED PRICES

Quarter Ended June 30, 2012

 

Oil

Gas

NGLs

Total

 

(Per Bbl)

(Per Mcf)

(Per Bbl)

(Per Boe)

United States

88.74

1.72

29.5

22.86

Canada

54.88

1.91

45.87

34.66

Realized price without hedges

67.67

1.76

31.42

26.18

Cash settlements

4.17

0.9

-

4.33

Realized price, including cash settlements

71.84

2.66

31.42

30.51

 

Quarter Ended June 30, 2011

 

Oil

Gas

NGLs

Total

 

(Per Bbl)

(Per Mcf)

(Per Bbl)

(Per Boe)

United States

98.28

3.72

40.43

33.19

Canada

73.65

4.08

58.8

45.55

Realized price without hedges

83.31

3.8

42.2

36.63

Cash settlements

-1.49

0.31

0.05

0.99

Realized price, including cash settlements

81.82

4.11

42.25

37.62

Cash Flow, Capital Expenditures and Debt

Cash flow from operations for the second quarter clocked in at $1.4 billion, showing a decrease of 8%, compared to cash flow from operations of $1.55 billion in the same period last year, as the company had a lower adjustment for deferred taxation in 2011.

Capital expenditure, on the other hand, increased by 15% to reach $2.2 billion for 2Q2012, compared to $1.9 billion in 2Q2011. The increase in CAPEX is due to increased drilling for oil production.

The company has total outstanding debt of about $10.8 billion and the debt-to-equity ratio is 49.37%

Hedging Through Derivatives

As disclosed by the company in its announcement for 2Q2012 results, and as shown above, DVN has hedged about 85% of its oil production and 65% of its gas production at weighted average prices of $97 per barrel and $3.76 per million cubic feet (MCF) for the next two quarters of 2012.

Reserves, Production Mix and Long-Term Production Target

DVN has total reserves of 3 billion BOE of oil, natural gas and natural gas liquids, of which 42% are liquids reserves. The production mix of the company is 63% natural gas, 22% oil and 15% natural gas liquids.

DVN intends to increase its production from about 679 MBOE at present, to 905-955 MBOE by 2016. The company also intends to shift its production mix to 48% natural gas, 32% oil and 20% natural gas liquids by 2016.

Lease Operating Expenses (LOE)

DVN's lease operating expenses have increased to $513 million, and on a unit production basis, have increased 10% to reach $8.3 per BOE for 2Q2012, compared to the same period last year. The increase in LOE shows the higher industry costs, along with increased drilling in oil focused reservoirs, as oil production projects have higher operating costs than gas production projects.

Outlook

The company, as mentioned above, has achieved growth in its oil production, and it intends to continue this trend going forward. The company is currently a play on prices of natural gas, as 68% of its production is natural gas. Natural gas prices have rebounded after bottoming at $1.84 per MMBTU in April, and are currently hovering around $3.20 per MMBTU, and this rebound is expected to continue in the future due to increased demand for natural gas, which will be beneficial for DVN.

DVN's production interests in the Permian basin and Canadian oil sands, along with its other interests in the U.S., including the Barnett shale, are expected to yield positive results for the company going forward.

DVN is trading at cheaper forward P/E, P/B and P/S multiples of 14x, 1.08x and 2x, as compared to its peers, and is offering a dividend yield of 1.35%. Given the above mentioned growth factors and strong fundamentals, we have a positive stance on the stock.

Name

P/E (X)

DPS

Dividend Yield (%)

ROE (%)

P/B

P/S

Devon Energy Corp

14.27

0.80

1.35

10.49

1.08

2.01

Chesapeake Energy Corp (CHK)

58.34

0.35

1.86

10.93

0.74

1.06

Anadarko Petroleum Corp (APC)

19.75

0.36

0.52

-13.66

1.89

2.45

Apache Corp (APA)

8.12

0.68

0.79

17.18

1.17

2.01

Sector average (Mean)

24.49

0.67

1.44

11.41

2.83

3.55

Sector median

19.75

0.56

0.85

11.32

2.10

2.62

Source: Buy Devon Energy: A Cheap Play On Natural Gas Price Reversal