Devon Energy Corporation (DVN) posted lower-than-expected earnings in the second quarter, reporting $1.18 per undiluted share, or $0.55 per share, excluding one-time items. Just ahead of earnings, analysts expected Devon to report earnings closer to $0.81 per share. Last year, in the same quarter, Devon reported earnings of $6.50 per share, but this number was inflated by the sale of its Brazilian assets, drastically reducing the usefulness of year-over-year comparisons.
Devon is staying light on its feet and on its balance sheet, with several recently inaugurated joint ventures that hold promise for profitability, including a recent deal worth $1.4 billion with Japanese giant Sumitomo. In exchange for a 30% interest in Devon's Permian Basin holdings, Sumitomo will pay $340 million in cash and up to $1.025 billion in a drilling carry in the first three years of the agreement. This puts the per acre value of the deal around $6,500, far above the per acre cost hoped for by rival Chesapeake Energy (CHK), which is hoping to close a sale on its 1.5 million Permian acres around $3,333 per acre.
Strong Growth Prospects, but Oil Sands Competition Heating Up
With the cash freed up in the Sumitomo joint venture, Devon will be able to pursue additional liquids plays without taking capital expenditures from ongoing plays or drilling objectives. This freedom is in addition to the boost Devon received from its $2.5 billion joint venture with Sinopec earlier this year, in which Devon received a $900-million cash payment and a $1.6-billion drilling carry.
Sinopec is on a tear with its joint ventures; just last month, it announced the purchase of a 49% interest in Talisman Energy's (TLM) North Sea Operations for $1.5 billion. Talisman was eager to conclude a deal after consistently poor results in its exploration attempts. Though a select number of producers, like Marathon Oil (MRO) are doing well in the North Sea, many are feeling the pain of steep drop-offs in production as the field reaches maturity. This is likely why Sinopec showed interest in the field, as most who are watching the moves of both Sinopec and CNOOC expect that these foreign partners are looking to acquire knowledge and experience as much as profit in recent deals. This represents a potential trouble spot for Devon and other partners once these foreign conglomerates pull out of the U.S. domestic market - or strike out on their own.
Devon is surging ahead with its Canadian oil sands projects, which reported a 63% increase in production in the second quarter of 2012 over the second quarter a year prior. This is important for Devon considering the massive investments in equipment, personnel, and exploration already invested in the projects. Sinopec also has a significant investment in Canadian oil sands, although not with Devon. As part of the Syncrude Project, Sinopec is operating with Murphy Oil (MUR), Suncor Energy Oil and Gas Partnership, a subsidiary of Suncor Energy (SU), and others.
The heavy hitting names behind the project, which include Exxon Mobil (XOM) through its ownership stake in Imperial Oil Limited, showed renewed interest in oil sands around the same time Devon went underway with its Jackfish developments. Although in the near term, the proximity of the Syncrude Project helps even out costs in and attract qualified workers to an otherwise remote area, success by others in this area will eventually invite more players to the oil sands, driving up prices across the board. Devon, with $7 billion cash and short-term investments on hand, would not have a problem paying premiums in the short term, but in the long term, given the complexity and estimated ultimate recovery of the oil sands, higher lease prices would almost certainly drive realizations below the cost of production.
The third quarter might look better for Devon, as natural gas prices are showing signs of rebounding and Devon's heavier focus on oil production begins to pay serious dividends. Devon will also see the benefit of the $90 million sale of its gathering and processing assets in the Barnett Shale to Crestwood Midstream Partners LP (CMLP). Crestwood should be able to turn these facilities to better account, as it already operates several similar platforms in the vicinity, and through the deal, Devon will still be able to utilize the pipelines to work on increasing its recovery rates, as well as increase its marketing reach.
Legendary oilman T. Boone Pickens, through his company BP Capital, is taking advantage of the opportunity to pick up shares in Devon at a discount, among other energy stocks, unloading all of the company's shares in Chesapeake and most of its holdings in SandRidge Energy (SD) at the same time. In a statement, Pickens indicated that the reason for the change was to move BP Capital's positions to more oil weighted stocks, a reasonable move except for the fact that SandRidge is heavily liquids weighted.
Devon is trading around $59, with a price to book of 1.1 and a forward price to earnings of 8.7, reflecting a recovery after a drop over reactions to its second quarter earnings release, but still a discount to the stock's potential. Marathon is trading at a similar value and discount, with its price around $27 and a price to book of 1.1 with a forward price to earnings of 7.6. SandRidge is trading around $6 with a price to book of 1.1 and a forward price to earnings of 14.8, while Talisman is trading around $14, with a price to book of 1.4 and a forward price to earnings of 13.0. Finally, Murphy is trading around $55, with a price to book of 1.1 and a forward price to earnings of 8.5.
What sets Devon apart, despite its similar value ratios to peers, is its commitment to navigating its way to growth without further debt acquisition. Its debt to equity of 0.4 is among the best in the industry, and with significant cash on hand, as well as drilling carries from its joint venture partners, it is hard to envision a scenario where Devon would take on major debt. This is diametrically opposed to most of its competition, and just one of many reasons Devon is a solid buy right now.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.