Buy Devon In Q4 For Long-Term Investment

| About: Devon Energy (DVN)
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Devon Energy (NYSE:DVN) is an independent energy company that engages primarily in the exploration, development and production of oil, natural gas and natural gas liquids. But, it has had to change direction because of the drop in natural gas prices. When hydraulic fracking was developed to the point where extracting natural gas became economical, many energy companies began drilling for natural gas. Eventually the market became saturated, and the price of natural gas dropped to near ten-year lows. Devon was caught up in the cycle that led to the over-production of natural gas and as a result, its earnings have suffered, and its stock price is at its 52 week low. Despite the fact that Devon's stock price is down investors should not give up on this stock. The third quarter earnings report does not look good, but there are some definite positives in this company's future.

Devon reported third quarter earnings on November 7th, and the results were disappointing. Revenues were $1.86 billion, down 88% from revenues of $3.5 billion in the third quarter of 2011. Net income was -$719 million, down from net income of $1.04 billion in the third quarter of 2011. Earnings per share came in at -$1.78, down from $2.50 per share in the third quarter of 2011. The primary reason that earnings were down was the $1.1 billion non-cash asset impairment charge because the carrying value of its oil and gas properties fell.

Other companies in Devon's business sector also took large impairment charges, for instance Apache (NYSE:APA) took a third quarter impairment charge of $861 million, and Chesapeake Energy (NYSE:CHK) took a third quarter impairment charge of $2 billion. Analysts on average expected Devon to turn a profit of 69 cents per share on revenue of $2.27 billion, according to Thomson Reuters I/B/E/S. Devon missed analyst estimates on both revenues and earnings and that was the straw that pushed its stock price to a new 52 week low.

In what could be considered good news for Devon, the company generated $1.9 billion of operating cash flow during the third quarter, and its financial position is still relatively strong. Devon ended the quarter with $7.5 billion in cash and a debt load of $11.2 billion or net debt-to-cap ratio of 15%. The company's relatively strong balance sheet will give it flexibility, as it changes its focus from natural gas production to oil production.

Devon, like its competitors Anadarko Petroleum (NYSE:APC), Apache and Chesapeake Energy, was compelled to change its focus from drilling for natural gas to drilling for oil. Devon was forced to make the adjustment because the margins for oil sales were much higher than the margins for the sale of natural gas. During the third quarter earnings call, Devon's CEO John Richels said, "We continue to invest the majority of our capital in high-margin North American oil projects. Our U.S. oil production, which is our highest margin product, grew 26% in the third quarter, and that was driven largely by our success in the Permian Basin." The company's overall oil production increased by 14% from the third quarter of 2011. CFO Jeff Agosta said, "the oil side of our business delivered most of our year-over-year growth, outpacing the decline in natural gas. In aggregate, oil sales, not including NGLs, once again accounted for more than 50% of our total upstream revenue in the quarter." If Devon wants to regain investor's confidence it will need to continue to increase its oil production along with its profit margin which is 7.23%.

Recent News About Devon Energy

On November 8th, Devon Energy was cut to Neutral from Buy at UBS following two production misses and expectations of flat production on a quarter over quarter basis. The disappointing growth trajectory led the firm to cut expected 2013 production by ~4%. DVN also raised 2012 capex for the third time this year, with only a $500M year-over-year reduction in 2013. Shares received at least two other downgrades

On November 7th, Devon's earnings swung to a net loss of $719M from a profit of $1B a year earlier, due to a $1.1B asset impairment charge as a 30% year-over-year slump in natural gas prices reduced the carrying value of Devon's assets. Cash flow from operations was $1.4B. Oil production was up +14% to 143K bpd, and U.S. oil output was up +26%. Total oil production was up +3% to 678K oil-equivalent barrels per day.

On October 11th, Devon Energy unveiled plans to consolidate its U.S. exploration and production operations group at its Oklahoma City headquarters, resulting in the closing of its Houston office. DVN is aiming to save ~$80M/year; it expects to post restructuring charges of ~$125M, including ~$100M in Q4.

On October 2nd, it was reported that a more robust outlook for natural gas prices is lifting prospects for producers Devon Energy, Comstock Resources (CRK) and Cimarex Energy (NYSE:XEC), FBR Capital said in upgrading shares to Outperform. "U.S. natural gas market fundamentals have already undergone substantial structural realignment needed to balance the market," FBR says.

On August 21st, Devon Energy led Morningstar's list of 10 high conviction stocks, noting that DVN is widely perceived as a gas company, but 80% of DVN's revenues and 80%-plus of its business value estimate stem from the oil and liquids business. Oakmark's Bill Nygren, part of the Morningstar group, estimates the stock now trades at just over half its 2013 asset value.

Stock Analysis

Devon's stock price, like those of most of its competitors, has suffered because of low natural gas prices. The stock price is currently right at its 52 week low, and over the last 52 weeks the stock price is down by 18%. The good news is that the company has been able to ramp up its oil production and because of reduced drilling and increased natural gas consumption; the price of gas has begun to move higher.

I believe that the stock prices of natural gas producing energy companies are near their bottoms, and that Devon's stock price will begin to move higher. Devon's stock price should increase because of its increased oil production. Investors with a longer term outlook will like the stock because natural gas prices will almost certainly be moving higher. Devon's stock is relatively cheap with a forward PE of 12.01 and a price to book ratio of 0.98. I believe that Devon's stock is a good long-term buy at this price (around $52), and if we have a cold winter the stock price could begin moving higher by Christmas.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.