Devon Energy: A Top Pick In U.S. Energy Producers

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We think Devon is one of the best energy plays going today, and market is not rewarding them for the value they bring. We rate them as a strong buy at current prices.

Note- this article appeared several weeks ago in the Daily Drilling Report membership service!

The thesis for Devon Energy

Devon has gone through a lot of changes since withdrawing from its deepwater and international exposure about a decade ago, to concentrate on U.S. unconventionals. It has a fairly lengthy history amassing almost five decades since its inception by the Nichols family who still run it today, to its current status as the 297th largest U.S company. A series of acquisitions have brought to it its current massive U.S. acreage position of some 1.8 mm net-acres, across four major shale plays. In 2000, DVN got its core Permian footprint from the $2.3 bn acquisition of Santa Fe Snyder. Others followed in fairly quick succession as DVN built the portfolio it has today, including the Mitchell Energy Barnett shale acreage in 2002 for $3.5 bn, acreage it's now selling for $770 mm.

DVN

I think I've bored you enough in recent times with descriptions of oil reservoirs, so with the exception of the Permian, we are going to skip the isopach maps in this article and focus on the really important stuff. What you need to know here is that the company has a wide footprint across a number of shale plays, but is particularly strong in the Permian.

We think U.S. shale assets will begin to be revalued higher in the coming months, and Devon is an outstanding way to play this prospect.

By the numbers then, Debt, Liquidity and Free Cash Flow to cover capex

DVN

$4.7 bn in total liquidity with a third in cash is comforting. With costs covered (capex of ~$950 mm projected for 2020 (75% allocated to the Permian-Delaware), debt expense, G&A, and LOW), at $35 bbl they shouldn't draw down either their cash or credit line to maintain operations.

With only $560 mm of debt due before 2031, we can take the discussion of debt off the table with a notable exception. The upcoming tender to use cash to reduce debt by $1.5 bn, over the next year or so. This is a bold move that underscores management's confidence in their operations going forward. Jeff Ritenour, EVP and CFO of Devon comments-

As it relates to the debt repurchase, the $1.5 billion that we've highlighted, our expectation is to do probably a mix between open market and tender. That's going to be dependent upon market conditions. So we're going to evaluate the maturities across the curve and where the best value sits. And then we'll enact that as we work our way through the rest of this year and likely into next year as well.

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We've already established that DVN doesn't have a debt problem of any kind. This level of conservatism impresses me. There has been a narrative that money's cheap, borrow your way to wealth prevalent the last few years. Over the last couple of years, we've seen that mentality explodes otherwise good companies. I don't like debt and avoid it in my personal life. DVN management is targeting an extremely conservative Debt to EBITDAX ratio of 0.5-1.0 once the debt repurchase is accomplished.

Free Cash Flow

With $40 WTI, DVN is on track to generate ~$500 mm in free cash for 2H of 2020, and ~$1.2 bn in free cash in 2021. This substantially exceeds their dividend expense of ~$168 mm annually, suggesting to me that down the road DVN is in a position to substantially increase this dividend. Jeff Ritenour, CFO, makes a fairly strong statement in this regard in the call-

A distinction for Devon versus some of our peers is, we have the cash on hand to accomplish our debt objectives, our target debt levels. So any free cash flow that we generate can then go back to shareholders, as Dave articulated.

A lot of other folks in the sector are going to have to generate free cash flow and then try to accomplish their lower leverage objectives. But we're in a unique position with the cash that we have on hand. We can take care of that and then generate free cash flow with the lower break-evens that we've created and return that to shareholders.

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Devon Operations

Delaware Basin: Net production averaged 149,000 Boe per day, a 24 percent increase compared to the year-ago period. In the second quarter, Devon's Wolfcamp-oriented capital program brought 22 operated wells online across Southeast New Mexico. Completed well costs for activity targeting the Wolfcamp formation improved to a new record of $700 per foot. In addition to capital efficiencies, the company continued to lower its operating costs, with production expenses declining 20 percent year over year to $7.58 per Boe.

                            VNSMART