Will Devon Energy's Huge Bet Pay Off?

Horizontal-drilling pioneer Devon Energy (NYSE: DVN  ) seems keen to capitalize on its head-start over fellow drillers. Higher demand for natural gas and better technology to tap it will only intensify Devon's competition, but the company is making smart moves to prepare for that future.

Onshore leader?
To position itself as North America's premier onshore exploration and production company, Devon has sold offshore assets over the past year, including those in the Gulf of Mexico. The company expects to make more than $8 billion from these sales after taxes.

Devon now wisely plans to focus on onshore reserves, following considerable past success there. Of the 228 million barrels of oil equivalent (Mmboe) that the company produced in 2010, 223 million -- an overwhelming 98% -- came from North American onshore reserves.

Past performance
Earnings before interest, taxes, depreciation, and amortization dipped 11% in the last 12 months, as Devon's offshore operations dwindled. Investors shouldn't worry, though; minus the eye-popping $2.1 billion that discontinued operations contributed, net income rose by a healthy 41% in the same period.

Devon's respectable 9.1% return on equity nonetheless slid from 14.7% a year before. The company hopes that buying back $3.5 billion in common stock repurchase will return value to shareholders and push that ratio back in the right direction.

How is the stock valued?
Here's how Devon stacks up against its peers:

Company

TEV/EBITDA

P/E (TTM)

Price/Book

Forward PEG
(2-Year)

Devon Energy 7.4 20.4 1.7 1.4
Petrohawk
(NYSE: HK  )
13.7 90.8 2.0 0.6
EOG Resources
(NYSE: EOG  )
12.7 143.8 2.3 0.4
Chesapeake Energy
(NYSE: CHK  )
9.8 24.4 1.5 2.8
Apache
(NYSE: APA  )
5.5 12.7 1.9 0.8

Source: Capital IQ, a Standard & Poor's company. TTM = trailing 12 months.

Devon's stock looks quite cheap when compared to its peers. I expect its total enterprise value to drop once its asset sales help the company pay down its debt. A price-to-book of 1.7 further suggests that the market values Devon's assets far more cheaply than their true worth. Its proved reserves of more than 2.8 billion Mmboe should generate good returns in the long run.

In the next few years, Devon's growth looks better than that of Chesapeake. That outlook could further improve once natural gas demand picks up and the company increases production.

Foolish bottom line
Devon shows a lot of promise. If you agree with me about the industry's general forward looking trends, this stock might be for you. However, I still believe the company's future depends heavily on the success of its strategy to sell its offshore operations.

Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Devon Energy. Motley Fool newsletter services have recommended buying shares of 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.


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