1 Energy Stock I'm Buying Today

This article is part of our Rising Star Portfolios series.

The next stock I'm buying for my portfolio is Devon Energy (NYSE: DVN  ) , a well-managed oil and gas exploration and production company with a diverse set of assets, a strong balance sheet, and cheap valuation.

Recent transformation
Over the last two years, Devon Energy has sold off its assets in the Gulf of Mexico, China, Azerbaijan, and Brazil for a total of $8 billion after tax. The company's aim is to focus on production in onshore North America.

Here's how Devon has fared in onshore North America over the last five years:

Year

Production (millions of barrels of oil equivalent)

Reserve Replacement (% of production replaced)

2006 168 233%
2007 183 198%
2008 207 269%
2009 220 223%
2010 223 175%

Source: Company's investor presentation.

From the table, it's easy to see that production and reserves have grown nicely. A reserve replacement ratio of 100% would mean that oil and gas are being replaced about as quickly as they are being produced. A ratio of 175% to 269% from the above table shows that Devon has been growing its reserve base much more quickly than it has depleted it over the past five years. This leads to more future cash flow, which can then fund more drilling projects and increase reserves even more.

If you recall, the assets outside of North America have only recently been sold. That means even while Devon was operating assets all over the world, it managed to grow production and reserves quite nicely in North America. Flush with cash from the asset sales and ready to focus on just the U.S. and Canada, Devon should have no trouble accelerating its growth.

Now, let's examine Devon's major assets:

  • Oil sands: Multiple Jackfish and Pike projects in Canada, each with an estimated ultimate recovery of 300,000 barrels of oil.
  • Lloydminster: 2.7 million net acres of oil in Alberta and Saskatchewan.
  • Barnett shale: 623,000 net acres in Texas with 7,000 risked drilling locations.
  • Woodford shale: 243,000 net acres in Oklahoma with more than 5,000 risked drilling locations.
  • Granite Wash: 63,000 net acres in Texas and Oklahoma with up to 200 million barrels of oil equivalent.
  • Permian basin: 1 million net acres in New Mexico and Texas with up to 1 billion barrels of oil equivalent.
  • Canadian exploration: 4 million net acres of Cardium (light oil), Viking (light oil), and Lower Cretaceous zones (liquids-rich gas).
  • New ventures: 1.2 million net acres in the Niobrara, Mississippian, Utica, Michigan, and Tuscaloosa shale plays.

Without counting the significant oil sands projects and other minor acreage positions not listed, the above list still yields almost 10 million net acres of land to develop. They include shale gas, conventional light oil, shale oil, and heavy oil plays. Even without leasing any more land, Devon has a massive drilling inventory just waiting to be developed.

So now, we see that Devon has built up its war chest from asset sales and has a huge collection of drilling locations on which to deploy that cash. Let's examine how it stacks up against some of its peers:

Company

Devon Energy

EOG Resources (NYSE: EOG  )

Chesapeake Energy (NYSE: CHK  )

Noble Energy (NYSE: NBL  )

Anadarko Petroleum (NYSE: APC  )

TTM Operating Cash Flow $5.5 billion $4.0 billion $4.9 billion $2.3 billion $5.9 billion
Market Cap $26.6 billion $27.2 billion $17.7 billion $16.0 billion $41.1 billion
Net Debt $2.4 billion $3.8 billion $11.7 billion $2.6 billion $10.4 billion
Price / Operating Cash Flow 4.9 6.9 3.6 7.0 7.0
P/B Ratio 1.3 2.2 1.1 2.1 2.1

Source: S&P Capital IQ.

Based on the table above, the two stocks that stand out as the cheapest by both price/book ratio and price-to-operating-cash-flow multiple are Devon and Chesapeake. However, we see that Devon, despite its bigger market capitalization, has a net debt position of only $2.4 billion compared to Chesapeake's $11.7 billion. Devon's ability to generate cash is also quite impressive, generating almost as much operating cash flow as Anadarko despite being valued as a much smaller company.

Going forward, Devon plans on putting its recently acquired cash to work. The company plans to develop existing inventory, grow its oil and liquids production by at least 16%, and accelerate the exploration of many of its main acreage positions, especially in Canada and the Permian. If the company maintains a disciplined capital spending program, it should be able to grow production and reserves quite rapidly over the next several years.

Growing production, increasing reserves faster than they are depleted, and maintaining a strong balance sheet are all top goals of oil and gas producers, and it looks like Devon Energy is in prime position to do all of these things. As long as management continues to focus on disciplined capital allocation, the company should have a bright future ahead.

Foolish bottom line
The landscape of the North American oil and gas has changed drastically in just the last decade with the advent of the shale plays. In order to take advantage of the prolific production out of the U.S. and Canada, I have decided to add Devon Energy to my portfolio, an explorer and producer with a diverse set of assets, a strong balance sheet, and cheap valuation.

Paul Chi owns shares of Chesapeake Energy. 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.


Read/Post Comments (3) | Recommend This Article (33)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 03, 2012, at 10:33 AM, nonzerosum wrote:

    Thanks for the article! Looking at reserve replacement is a great way to see whether this energy company is just spinning its wheels (most of them have very low FCF), or if they're doing something for shareholders. At the end of 2007 one share of DVN gave you debt adjusted ownership of 3.8 Boe of reserves. At the end of 2010 it was 4.4 Boe. So, indeed, they are improving things for shareholders. However, they've been piling on debt so that is something to watch.

  • Report this Comment On February 08, 2013, at 1:43 PM, mview wrote:

    Is DVN in gas drilling? If so, what is the ratio between gas and oil? What is your sense of gas price in the next 6 to 12 months?

    thanks.

    -M

  • Report this Comment On February 08, 2013, at 11:51 PM, LAVol wrote:

    Location, location, location. Those are the 3 reasons that EOG is in better position than Devon. With key positions in Eagle Ford, Haynesville, Bakken, and Marcellus, EOG is one of the best positioned oil and gas companies. As for the oil sands touted above, Oil has to be near or above $90 for oil sands to be economically recoverable. I don't see oil staying above $80 for an extended period of time. We have too much of it in the U.S. By the end of 2015, the U.S. will be a net exporter of oil. Supply and demand--the price just can't stay over $80. I could see it in the 50's by 2016. I really don't like any oil exploration/production companies in the next 5 years. Drilling and service companies will do better.

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