Devon Energy Sells Assets, Increases Capex And Production Outlook

| About: Devon Energy (DVN)
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Yesterday, Devon Energy announced another tranche of asset sales that allowed it to exceed the bottom end of its divestiture target.

Devon has announced more than $1.8 billion of divestitures over the last two weeks and will likely end this month on an even higher note.

Devon Energy is planning to ramp up drilling activity in the coming months, but it isn’t alone.

Previously, I wrote that Devon Energy (NYSE:DVN) could achieve its objective of selling $2 billion to $3 billion of non-core assets within weeks, and that might have a positive impact on this stock. Yesterday, the company announced another tranche of asset sales which allowed it to exceed the bottom end of its target, and the stock was up more than 2% during after-hours trading.

Asset sales

Devon Energy had already announced sale of $1.3 billion of assets and was just $700 million short of achieving its asset sale target. On Wednesday, the Oklahoma-based oil and gas producer said that it is selling $858 million of non-core exploration and production assets, located in Texas' Midland Basin to Pioneer Natural Resources (NYSE:PXD) and an undisclosed buyer for $858 million.

It is selling 28,000 net acres in northern Midland Basin, mainly around Martin County, to Pioneer Natural Resources for $435 million. This is largely oil-rich, undeveloped acreage from where Devon Energy has been producing 1,000 barrels of oil equivalent per day, which was 70% oil. In another deal, Devon Energy is selling its southern Midland Basin properties, which were responsible for production of 22,000 barrels of oil equivalents per day which was 3% oil, to an undisclosed buyer for $423 million. Including the latest transactions, Devon Energy has announced sale of $2.1 billion of non-core assets in 2016.

Devon is benefiting from the recent strength in oil prices which have climbed to almost $50 a barrel after touching multi-year lows of less than $27 a barrel in February. The price for the U.S. benchmark WTI crude has been hovering near the high-$40s and low-$50s window since mid-May. This strength and stability in prices seems to have sparked a renewed interest in M&A activity in the energy patch.

Following improvement in oil price environment, oil producers ranging from Brazilian oil giant Petrobras (NYSE:PTR) to U.S. oil major Exxon Mobil (NYSE:XOM) are considering offloading some additional energy assets. A number of other energy companies, such as Southwestern Energy (NYSE:SWN), Penn West Petroleum (PWE), Natural Resource Partners (NYSE:NRP) and Rex Energy (NASDAQ:REXX) have announced asset sales in the first two weeks of June. Devon Energy tops this list with more than $1.8 billion of divestitures announced over the last two weeks; and it will likely end this month on an even higher note.

Devon Energy has been negotiating the sale of a major asset - its 50% interest in Access Pipeline in Canada. About ten days ago, the company said that it expects to make an announcement related to the pipeline "within the next several weeks." The company appears to be firmly on track to hit the top end of its divestiture target by the end of June.

The asset sales will give Devon Energy an opportunity to improve its financial health. The company is one of the heavily levered oil producers with a net debt (total debt minus cash reserves) of $10.56 billion. But it intends to use almost two-thirds of the proceeds from asset sales to reduce its debt. This means that if Devon ends up selling $3 billion of assets, it will use $2 billion to cut down its debt.

Devon Energy expects to close the latest divestiture of $858 million in the third quarter. It intends to close the previously announced $1 billion asset sale in the third quarter while the sale of $200 million of Mississippian assets in Oklahoma, which was disclosed in April, will close in the ongoing quarter. I expect the company to finish the sale of Access Pipeline by the end of 2016. Since most of the proceeds are going to be used to strengthen the balance sheet, the company's debt levels should fall significantly by the end of 2016. This should have a positive impact on Devon Energy's valuation which has been trading at a discount to its large-cap, under-levered peers, such as EOG Resources (NYSE:EOG), Apache Corp. (NYSE:APA) and Occidental Petroleum (NYSE:OXY).

Drilling activity

On the other hand, Devon Energy intends to use one-third of the asset sales proceeds to fund its capital program. Citing "success of our E&P asset sales," Devon Energy has increased this year's capital program by $200 million while also raising its 2016 production outlook by 7,000 barrels of oil equivalents per day from the previous guidance - though the increase in production outlook has been driven by better than expected performance from existing operations and has nothing to do with the uptake in capital budget.

Devon Energy now aims to spend between $1.1 billion and $1.3 billion as upstream capital in 2016 and plans to deploy three additional rigs at Delaware Basin and the Oklahoma STACK play from the third quarter. While this is not going to have any impact on this year's production, the increase in drilling activity will begin to lift Devon Energy's output from early 2017. If oil continues to improve to $60 a barrel in the fourth quarter of this year, then I believe Devon Energy could make another increase in capital budget.

Devon Energy's management probably believes that the recent strength in oil prices is sustainable, which is why the company is planning to ramp up of capital spending and drilling activity in the coming months. And Devon Energy isn't alone. Its peer Pioneer Natural Resources has also planned to deploy five new rigs in northern Spraberry/Wolfcamp region in 2016, starting from September. These could be early indications of a sustainable increase in U.S drilling activity, though we may not witness a meaningful rebound until prices increase to $60 a barrel and the high oil price environment gets firmly established.

It is worth mentioning here that US rig count has been climbing for the last few weeks. Data from Baker Hughes (BHI) has shown that the US rig count has increased for two straight weeks, though we haven't seen any double-digit gains yet.

Disclosure: I/we 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.