Does Diversity Devalue Devon?

Diversification of assets is a great thing, until it isn't. Some companies, like Apache (NYSE: APA  ) and Occidental (NYSE: OXY  ) , can do well managing a geographically diverse array of assets. With Devon Energy (NYSE: DVN  ) , though, I'm not so sure that this diversification has been quite so helpful.

For this second quarter, Devon reported that revenue rose about 6% from last year, with operating income rising about 4%. Though performance was helped by a 17% improvement in operating earnings from the midstream and marketing business, overall results were pressured both by a year-over-year decline in production and rising production costs.

I've expressed some of my concerns about Devon in the past, and those are still true today. The company is experiencing definite cost inflation as lease operating costs were about 19% higher on a per-barrel equivalent basis. Moreover, it's still highly exposed to natural gas (only one-quarter of production is oil) and does not routinely hedge that production.

What also concerns me, though, is whether the company's geographical diversification is really adding value. Both operating costs and finding and development costs have been higher in Devon's Canadian and international operations and have muted the strong returns from the company's U.S. operations.

Now, you can certainly argue that performance outside the U.S. is improving and that it would be unfair to pull the plug today. By the same token, I think there's a case to be made for Devon at least considering a sale/swap of its Brazilian, West African, Egyptian, Azerbaijani, or Chinese assets and reinvesting that either in areas like the Barnett Shale in Texas or perhaps a special dividend/share buyback. With operators like EOG (NYSE: EOG  ) , EnCana (NYSE: ECA  ) , and ConocoPhillips (NYSE: COP  ) all in the Barnett Shale, perhaps one of them could be induced to a swap or similar transaction.

Devon does appear undervalued, but not enough to get my attention or interest. With other companies offering more attractive production profiles and/or better cost and return structures, I'd need a bigger discount here before choosing Devon before them.

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).

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