Devon's Downgrade Overblown
cris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In late May, Wells Fargo (NYSE: WFC) downgraded Devon Energy (NYSE: DVN) from outperform to market perform, exchanging positions with competitor EOG Resources, which was upgraded by Wells Fargo from market perform to outperform on the same day. In reviewing the decision, Wells Fargo Analyst David Tameron said, “we think Devon currently lacks a niche within the large cap space, and believe shares will have a hard time outperforming in the next few quarters”. I think that Devon has a narrow niche in the Canadian oil sands with its Jackfish projects, at least as an independent producer. Additionally, if Devon will have a hard time outperforming, so will most of its competitors. I believe that the Wells Fargo downgrade is overly pessimistic in Devon’s case, since the company continues to act conservatively where it needs to and aggressively where it sees opportunity to support its growth.
Utica: Devon’s Base for Revenues
Devon currently has 340,000 acres above the Utica shale in Michigan and 235,000 acres above the Utica shale in Ohio, by far its most significant holdings in any one formation. Ohio is still struggling with its newfound position as an energy producer, as state and local government, residents, and the oil and gas companies that want to produce on the Utica shale try to arrive at mutually agreeable regulations for fracking activities. Recently, a new energy bill that addresses drilling activity in the state passed the Ohio Senate and made its way to the Ohio State House of Representatives, where it awaits a vote.
On May 21, many Ohio residents, some of whom support an outright ban on injection wells for frack water disposal, testified before the House Public Utilities Committee about their concerns over the bill and proposed activities. Given that with current technology fracking is required to extract most of Ohio’s resources, legislation that would ban injection wells is outright unlikely. However, I think Devon and its peers on the Utica, including Chesapeake Energy (NYSE: CHK), will need to work harder at public relations here to overcome public reticence, instead of relying on the state government to do the heavy lifting.
Devon is making a play for good publicity with its new Oklahoma City headquarters. The company chose a site for its new building with a history of poor environmental stewardship, a location that over the years became polluted by fuel leakage from previous incarnations as a trolley depot and a combination service garage and parking deck. With the compromised property, Devon is aiming for gold LEED certification by cleaning up the pollution, recycling most of the unsalvageable materials from the original structures, and using LEED features for the new building. This won’t be big news outside of Oklahoma City, but considering Devon’s base in the state it could be a public relations win for the company.
Is Canada the Home of the “Secret Play”?
Devon is “building significant acreage in an additional undisclosed oil position”, for which it currently has 250,000 acres and wants to build up to 500,000 acres. I think it’s entirely possible that this acreage is in Canada, and if it is, Devon has an opportunity to be an early arrival in what is shaping up to be the next hot North American play.
Devon is bearish on the prospects of a natural gas price rebound, targeting Henry Hub prices at just $4.50 in 2016, from $2.75 today. In response Devon is ramping up its LNG projects, giving guidance that LNG production will increase from 46,000 barrels per day in the first quarter of 2012 to between 150,000 and 175,000 barrels per day in 2020. This increase in LNG production is unlikely to come from Devon’s current holdings alone, and most of the plays in Canada produce both oil and natural gas.
Devon is currently participating in Canadian oil sands with its Jackfish projects. Jackfish began with first production from Jackfish 1 in 2007, followed by Jackfish 2 in 2011, with Jackfish 3 slated to begin production in late 2014. The infrastructure and relationships that Devon built to support increasing investments in these projects would make further Canadian investment a likely candidate for this so-called “secret play”.
Devon has the infrastructure in place for Jackfish at current volumes with an access pipeline to the Edmonton hub, for which it plans to file an application that would double capacity this year – another indication that its secret play may be located somewhere in this area. There are currently few pipelines in place carrying to the Pacific Northwest. However, there are several pipelines in the works that would extend the pipeline infrastructure west from Edmonton to the coast, including Enbridge’s Gateway Pipeline project, as well as projects to open transportation south to the Gulf hubs and refinery infrastructure, which would include the Chinook Pipeline project, among others. This building infrastructure would support further investment in what just a few years ago was mostly inaccessible.
On May 23, Devon presented at the UBS Global Oil and Gas Conference. There were no surprises in its presentation, but it did provide simplified snapshots of its first quarter earnings as well as more in-depth guidance for the company. One of the more revealing indications is that the company is aiming to deliver share results within the top 25% of its peer group. I do not believe that this goal is unrealistic for the company, as it continues to deliver steady results in a tough market.
I also think Devon is wise to be bearish on natural gas prices, considering that the company has no shortage of opportunities elsewhere that promise greater revenue streams. The identity of its secret play is eagerly awaited by those who follow the energy industry, including myself, and I think that once the secret play is revealed the stock may see a sharp rise just based on initial reactions. Either way, shares of Devon are currently trading below value, at $60 with an enticing price to book of 1.1 and a forward price to earnings of 8.7. Despite the recent analyst downgrade, I think Devon is still more than worthy of consideration.
jewishitalian31 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.