Is This Oil & Gas King Trading at Fair Value?
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
TheStreet Ratings has reiterated its hold rating on Devon Energy (NYSE: DVN) citing among its strengths a solid financial position based on different debt and liquidity measures. Among the negative factors noted were disappointing stock performance, feeble EPS growth and deteriorating net income. The company's earnings per share (EPS) has declined over the last year and is expected to continue to decline in the coming year. Morgan Stanley has also initiated coverage and issued an equal weight rating on the stock with a $56 price target. According to the company, operational setbacks have hurt its 2013 growth outlook significantly. It is believed that its large exposure to weaker pricing for gas, NGLs, and heavy oil will provide the company with challenges. And these problems have been largely discounted in the prevailing stock price. Devon's problems are offset by the flexibility that its low leverage offers, and its initial success in scalable emerging plays.
Devon has reported a net loss of $719 million for the quarter ended September 30, or $1.80 per common share ($1.80 per diluted share). The loss was principally because of a non-cash asset impairment charge of $1.1 billion. Adjusting for this and other one-off items normally excluded by analysts in their calculations, the company earned $355 million or $0.88 per diluted share in the third quarter of 2012. It generated cash flow from operations of $1.4 billion during the quarter and, combined with $533 million in cash payments received from the closing of its joint venture agreement with Sumitomo and other small asset sales, Devon’s total cash generation was $1.9 billion in the quarter.
Devon continued to show strong oil production growth in the third quarter of 2012. Oil production averaged 143,000 barrels per day, which was a 14% increase compared to the same quarter of 2011. This was achieved despite the scheduled shut-down for facilities maintenance at the Jackfish 1 oil sands project, which resulted in production being reduced by approximately 10,000 barrels per day. The most important growth came from the company's U.S. operations, where year-over-year oil production grew by 26 percent. In total, Devon’s production averaged 678,000 oil-equivalent barrels (Boe) per day in the third quarter, a 3% increase year-on-year. Year-on-year declines in natural gas volumes were caused by reduced activity in liquids-rich gas projects, which partially offset the company’s oil production growth for the quarter.
Permian Basin oil production grew by 35% over the same quarter of the previous year, and oil production accounted for almost 60 percent of the company’s 65,000 Boe per day production in the Permian. In the Bone Spring and Delaware plays in the Permian Basin, the company added 25 new wells in the quarter. Initial 30-day production from these wells averaged 575 Boe per day. Also in the Permian, Devon brought five Midland-Wolfcamp Shale wells online in the quarter, with initial 30-day production averaging 560 Boe per day. In September, Devon terminated its $1.4 billion joint venture agreement with Sumitomo covering 650,000 net acres in the Permian Basin.
Devon has now successfully entered into two exploration joint ventures delivering almost $4 billion in value. In Canada, net production from Devon’s Jackfish 1 and Jackfish 2 oil sands projects averaged 44,000 barrels per day during the quarter, which represents a 24 percent increase in oil production year-on-year. Construction of Devon’s third Jackfish oil sands project is now approximately 45 percent complete, and start up is expected by the end of 2014. The company’s activity in the Mississippian Lime play in Oklahoma was characterized by the increase in activity to 13 operated rigs and results continue to be on target.
The Cana-Woodford Shale production averaged 283 million cubic feet of natural gas equivalent per day in the quarter, while liquids production grew by 64 percent year-on-year.
Revenue from oil, natural gas and natural gas liquids sales amounted $1.7 billion in the quarter, representing an 18% decline from the third quarter of 2011 because lower priced realization for all three products more than offset the increased production. Cash settlements related to the company’s oil and natural gas hedges enhanced in revenue by $243 million or $3.89 per Boe in the quarter. Net cash inflows during the quarter were roughly equal to capital expenditures, and the company ended the quarter with a sound financial position. On Sept. 30, the company’s cash and short-term investments were $7.5 billion, and net debt to adjusted capitalization was just 15%.
The soundness of the company's financial position is evident when you compare it to some of its peers. Chesapeake Energy (NYSE: CHK) is now facing significant funding problems because of the complicated deals from earlier years for which it is having to pay the price. Chesapeake's capital expenditure outstrips the cash flow that it is able to generate from operations and, consequently, it is being forced to sell prized assets in order to meet its funding requirements.
Encana (NYSE: ECA) has a high debt to equity ratio currently at 1.4, but its failure to move to increased focus on liquids until recently has taken its toll off the company's finances. Encana's net losses for the year to date are in the region of $3 billion.
In my opinion, there are two companies that are worth considering as investment prospects in the same space. FX Energy (FXEN) is an independent oil and gas company which is focused on Poland. I think that the market is undervaluing the stock given the record third-quarter production and the new wells which will begin production in the fourth quarter. Another stock that looks interesting is Gale Force Petroleum (GFP) which is an aggregator of undervalued and underdeveloped shallow oil and gas reserves in the Gulf Coast and the central U.S. The stock currently trades at a low enterprise value when compared to its production multiple as well as a low cash-flow multiple and there is scope for capital growth.
Despite its evident financial strength, I believe that Devon is fully and fairly valued. I do not recommend buying Devon at this point in time.
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