You Can Still Win in the Energy Sector...Here's How
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Devon Energy's (NYSE: DVN) results for the fourth quarter show the effect of both lower price realization for its major products, and impairment charges caused by the depressed state of the natural gas market. Below, I will examine these results and explain why Devon continues to be a strong investment choice for those looking at the oil and gas sector.
Devon reported a net loss of $357 million for the quarter ended Dec. 31, 2012, which works out to $0.89 per diluted share. The fourth-quarter results were affected by a non-cash asset impairment charge of $896 million. Devon earned $316 million, or an EPS of $0.78 per diluted share for the quarter. Because of the asset impairment charges, the company reported a loss of $206 million for the year ended Dec. 31, 2012, or $0.52 per diluted share. Excluding adjustments, the company earned $1.3 billion, or an EPS of $3.26 per diluted share in 2012.
Total production of oil, natural gas, and natural gas liquids grew to 250 million oil-equivalent barrels (Boe) for the year, which is the highest annual production total from its North American assets, and represents a 10 million Boe increase year on year. The increase in 2012 production was almost entirely because of growth in oil production, which grew by 20% over the previous year, more than offsetting declines in natural gas volumes because of diminished activity.
Devon also showed strong oil production growth in the fourth quarter of 2012 and oil production averaged 151,000 barrels per day, a 13% growth over the same quarter of the previous year. The most significant growth in oil production came from the U.S., where fourth-quarter production increased 30% over the same quarter of the previous year. As of Dec. 31, 2012, estimated proved reserves totaled 3 billion oil-equivalent barrels, and increased by 13% compared to 2011, offsetting declines in natural gas reserves.
In 2012, the company added 381 million Boe through successful drilling, and drill-bit capital invested during the year totaled $7.5 billion. For the purpose of reporting, $1.3 billion of cash proceeds received from the closing of two joint ventures were not subtracted from this figure, but reimbursed the company for the associated expenses incurred. Revisions to reserves, as a result of lower prices, resulted in a decrease in proved reserves of 171 million Boe as at Dec. 31, 2012, but these revisions affected only natural gas and natural gas liquid reserves. The reserve life index (calculated by dividing proved reserves by annual production) stayed at around 12 years, and proved developed reserves accounted for 72% of total proved reserves.
Although there was an increase in total production, revenue from oil, natural gas, and natural gas liquids sales declined 14% to $7.2 billion in 2012. However, cash generated by the company’s oil and gas hedges increased revenue by $870 million, or $3.48 per Boe in 2012, partially compensating for lower realized prices.
The strong oil price environment has given the company the opportunity to add oil hedges for 2013, and it now has entered into contracts to hedge 115,000 barrels per day of oil production. The company also recently increased its natural gas hedging position. For the full-year 2013, Devon now has approximately 1.3 billion cubic feet per day protected at a weighted average floor price of $3.87, which covers 60% of the expected natural gas production for 2013.
During 2012, cash flow generated from operations was $5 billion, and if the cash inflow from the closing of two joint ventures and net asset disposal is taken into consideration, total cash inflows for the year amounted to $6.5 billion. The company ended the year with a strong financial position, and as at Dec. 31, 2012, cash and short-term investments were $7 billion, and the company had a net debt to adjusted capitalization of 18%.
Results compared to consensus estimates
Devon reported fourth-quarter 2012 adjusted earnings per share of $0.78 which was a penny higher than the Zacks Consensus Estimate. However, the results were almost 50% lower compared to the same quarter of the previous year. On a GAAP basis, the company reported a loss of $0.89 a share, compared to earnings of $1.29 a share last year.
The difference of operating and GAAP number of $1.67 in this quarter was because of a non-cash asset impairment charge of $896 million for the year, Devon reported earnings of $3.26 per share which was 1.6% higher than the Zacks Consensus Estimate. Quarterly revenue of $2.58 billion were ahead of the Zacks Consensus Estimate of $2.38 billion, but short of revenue for the same quarter of the previous year by $4 million.
The full-year revenue amounted to $9.5 billion, ahead of the Zacks Consensus Estimate of $9.15 billion, but short of the figure for the previous year of $11.45 billion. The decline in year on year revenue was because of the lower average realized prices.
Chesapeake Energy (NYSE: CHK) is trading well below its 52-week high, and could have an upside based on the mean target price set by analysts of just over $23. The stock is currently trading at around $21. It is trading under book value, and the dividend yield is around 1.7%. Activist investors Carl Icahn and Mason Hawkins have increased their stakes in the company to around 9% and over 13%, respectively, and now control a substantial portion of Chesapeake's Board of Directors. These two have a great track record of creating value, and investors can certainly expect better corporate governance.
Chesapeake reported fiscal fourth-quarter revenue growth of 30% on a year-over-year basis, to $3.5 billion, while adjusted net income available to common shareholders declined 61%, to $153 million ($0.26 per diluted share). On average, analysts' consensus estimates was $2.9 billion for revenue with an EPS of $0.14. For the full year 2012, revenue at $12.3 billion was 6% higher than 2011 while adjusted net income was $285 million ($0.61 diluted EPS), compared to the previous year's $1.9 billion ($2.80 diluted EPS).
Hess (NYSE: HES) has a portfolio of high-quality assets comprised of U.S. liquids and overseas natural gas, which would normally be seen as favorable and well-balanced. However, management does not seem to be focused on economic returns, and the allocation of capital and resources. Would be investors need to believe that management can deliver production growth and enhance shareholder value before investing. Valued on the basis of its assets, Hess should probably commands a higher premium than the market is willing to provide, because it is both a major operator in the Bakken region and holds significant acreage in the emerging Utica area.
The biggest issue that investors have with Hess is the company's capital expenditure budgets in recent years. The company has incurred capital expenditure that has exceeded cash flow generated from operations, and forced it to sell assets and to incur debt. There is also a legitimate doubt about whether the company has not been sufficiently concerned with drilling costs and economic returns from its exploration and production. I recommending holding this stock.
Devon is financially strong and conservatively managed, which is an advantage in these difficult times for the industry. Devon currently trades at around $56, which is not exactly cheap on a valuation basis. However, any improvement in price realization would result in much better profitability. Moreover, the company has been able to successfully switch from natural gas to oil production, with the ability to switch back to natural gas if the price scenario improves.
Wall Street recommendations tracked by S&P Capital IQ indicate that the average opinion on Devon Energy is outperform, with an average price target of $71.78. If you are looking for exposure to the energy sector, I recommend buying this stock.
jordobivona has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!