The oil and gas exploration and production sector has significantly expanded over the past couple years, both domestically and around the world. With the advent of horizontal drilling and hydraulic fracturing, the U.S. is poised to overtake Saudi Arabia to become the world’s biggest oil producer before 2020, according to a new forecast by the International Energy Agency. Several oil and gas exploration and production companies are well positioned within the newly booming domestic industry [for more energy news and analysis subscribe to our free newsletter].
Devon Energy is a leading independent energy company focused on the exploration, development and production of oil, natural gas and NGLs, with operations in various North American onshore areas in the U.S. and Canada. Since being formed in 1971, the company has established itself as a pioneer of natural gas from shale and coalbed formations, a proven leader in using steam to produce bitumen from the Canadian oil sands, and one of North America’s largest processors of natural gas, with more than 5,700 employees worldwide.
Devon Energy’s properties encompass 14 million net acres, with only about one-third of the land developed. With production of approximately 682 MMBoe per year that’s 37.4% liquid and 62.6% gas, the company has some 2,963 MMBoe in proved reserves that’s roughly 46.9% liquid and 53.1% gas, setting the stage for higher margins down the road. These properties range from the non-conventional reservoir Barnette Shale, where Devon’s the largest producer, to the Canadian oil sands, where it became the first U.S.-based company to develop a bitumen project [see also Company Profile: Exxon Mobil].
In FY 2012, the company reported revenues that fell 17% year over year to $9.5 billion and diluted earnings from continuing operations that moved from a positive $5.10 per share to a loss of $0.47 per share. On the balance sheet, total assets that increased 5.4% to $43.4 billion were offset by a 41.6% increase in long-term debt that caused stockholders’ equity to fall just under 1% to $21.3 billion. These metrics could improve over the coming year, if energy prices improve and/or refinery and pipeline expansions occur in the near future.
Devon Energy has made a concerted effort to focus on higher-margin oil and bitumen projects, and it’s succeeded in growing this production by 20% in FY 2012, compared to just 4% production growth across all of its properties. Unfortunately, declining commodity prices overshadowed these gains and negatively affected revenues and proved reserve valuations.
The U.S. Energy Information Administration (“EIA”) projects that crude oil prices will continue this decline, falling from an average of $109.33 per barrel in FY 2013 to an average of $100.75 per barrel in FY 2014, while natural gas prices are expected to increase from an average of $11.12 per thousand cubic feet to an average of $11.83 per thousand cubit feet. While these numbers may prevent a further fall in energy prices, they may not contribute to all that strong of top-line growth.
Risks And Rewards
As with any oil and gas company, Devon Energy faces a number of different risks related to its reserves, production and pricing. Natural gas prices fell from their highs in 2008 to around $2.00 MCF in 2012, due to new technologies like hydraulic fracturing and horizontal drilling on the supply side and a warm winter that hurt the demand side. While the company expects demand to increase in 2013, contributing to stabilization and modest gains from 2012 levels, the natural gas industry has been notorious for its price fluctuations, creating a key risk.
Crude oil and bitumen production has also been negatively affected by lower natural gas prices, as producers focus on growing production in those higher-margin areas. While the company again predicts long-term growth in prices, there are always risks, both foreseeable and unforeseeable, that could have an impact on liquid prices. Long-term, the company must discover or acquire additional reserves in order to avoid a material decline in reserves and production over time as its current assets are depleted [see also 25 Ways To Invest In Crude Oil].
Over the past 52 weeks, Devon Energy’s stock price has been relatively volatile, with a beta coefficient of 1.22 and a 25% drop in price. The performance is concerning due to the fact that benchmark indices like the S&P 500 and Energy Select Sector SPDR (XLE) have risen 12% and 5%, respectively, over the same timeframe. Looking forward, seven analysts covering the company are largely neutral-bullish with three buy ratings, one outperform rating, and three hold ratings, and an average five year growth forecast of -1.8%, according to Morningstar.
Despite the lackluster growth and modest analyst ratings, the company may be trading at a discount to the market, its peers, and its own five-year average. The company’s price-to-sales (“P/S”) ratio stands at 2.3x, compared to an industry 2.7x and a five-year average 2.8x, while its price-to-book (“P/B”) ratio stands at 1.0x, versus an industry 1.7x and a five-year average 1.5x. These metrics may suggest that the stock could be overdue for a rebound closer to its averages over the coming quarters, particularly if its performance or energy prices pick up.
The Bottom Line
Devon Energy has underperformed the market over the past 52-weeks, but management is trying to turn things around by refocusing on higher margin liquids. However, with energy prices extending their bearish trend, the company could face an uphill battle to produce higher top-line results. The good news is that these trends have pushed the stock down to an attractive valuation, with P/S, P/B, and P/C ratios well below industry and the company’s own 5-year average levels, making the stock a potentially interesting play for large-cap value investors.
Disclosure: No positions at time of writing.