Positioning in Energy Large Caps Following the ExxonMobil / XTO Deal

Includes: APC, DVN, EOG, OXY, XOM, XTO
by: Kurt Wulff

ExxonMobil’s (NYSE:XOM) offer to acquire buy-recommended XTO Energy (XTO) sparks renewed investor interest in U.S. Independent Producer buy recommendations Devon Energy (NYSE:DVN), EOG Resources (NYSE:EOG) and Anadarko Petroleum (NYSE:APC). We suggest overweighting DVN because of its lower McDep Ratio. Much to our frustration, DVN has remained the lowest McDep Ratio stock most of the past three years without performing notably better for long. Because of such a possibility, we suggest that after achieving a reasonable overweight in a low McDep Ratio stock, move on to the next one.

Buy-recommended Occidental Petroleum (NYSE:OXY) was second lowest three years ago and subsequently delivered the best performance, helped by the highest oil concentration. During the same period, EOG has outperformed to reach a higher McDep Ratio compared to peers, underperformed to reach a lower McDep Ratio and then outperformed again to reach a higher McDep Ratio, currently above 1.0. As a result, we would consider reducing, or rebalancing, any large holding in EOG to average in Enterprise Value.

Devon Delivers Volume Growth without Deep Gulf of Mexico
Performance measurement is often sensitive to the time period chosen. At the beginning of the past three year period, Devon started with Net Present Value (NPV) that had just been raised about 13% to account for the company’s new discoveries and future potential in the deep Gulf of Mexico. Gradually, that extra value disappeared from NPV as we could justify undervaluation on current cash flow that did not include those properties. Now Devon has begun a divestiture of its Gulf of Mexico and international properties to raise about $6 billion, coincidentally the amount we had once attributed to the Gulf of Mexico properties. The proceeds are to be directed mostly to expanding production of natural gas from shale where Devon is a leader with the largest position in the largest producing field, the Barnett Shale of North Texas.

While Devon looked for extra growth offshore, XTO and EOG appeared to grow more rapidly by staying closer to home. Yet, when we consider the financing of growth and trace volume per unit, we see that Devon’s record is comparable. In the end, the similarities may be stronger than the differences. Each of our four continuing large cap buy recommendations is well-positioned to make money in oil and gas after XTO disappears into XOM.

Originally published on January 12, 2010