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Though they rose very recently, natural gas prices have been down in the dumps for quite some time. To avoid the downside from the depressed pricing environment, many energy companies have shifted their focus to more profitable oil and natural gas liquids. One company in particular is ahead of the pack. With a strong balance sheet and one of the lowest debt-to-market-cap ratios in the industry, it's leading the charge among oil and gas producers.
A divine energy play
Devon Energy (NYSE: DVN ) is primarily involved in the exploration and production of oil, natural gas, and natural gas liquids. The Oklahoma City-based company holds an impressive 13 million net acres throughout North America, of which around two-thirds are undeveloped.
Before I get into the details of why I like the company, here's why I like the stock: It's cheap. Devon shares are down big-time, having fallen nearly 25% from their peak in March and trading toward the lower end of their 52-week range. Moreover, shares are priced at just under nine times forward earnings, significantly lower than the industry average.
A changing strategy for changing times
For those worried about the effect of low natural gas prices on Devon's bottom line, a quick look at the company's new strategy should quell any major fears. Recognizing the poor economics of dry natural gas extraction, the company has expanded its reach into more profitable oil and higher-margin natural gas liquids production. Almost half of its risked resources are now concentrated in oil and NGLs.
For those who take the recent spike in natural gas prices as a signal for a recovery, Devon still has enough exposure to benefit from a price surge. And the company's agility in reallocating its resource base should serve it well if a resurgence in natural gas were to materialize. In a recent conference call with investors, CEO John Richels explained, "Our resource base provides the ability to shift investment to the most lucrative opportunities depending on market conditions."
Drillin' for a killin'
The new strategy is already paying off. In the first quarter, total onshore production was the highest in company history at 694,000 oil-equivalent barrels per day, a 26% year-over-year increase. In fact, Devon hit production records in nearly all of its four core operations.
While some oil producers like Kodiak Oil and Gas (NYSE: KOG ) are focusing exclusively on just one play -- in Kodiak's case, the Bakken -- Devon has solid footing in most major U.S. plays. It recently acquired significant acreage in the Mississippian lime play, a limestone formation encompassing parts of Oklahoma and Kansas. Because of tremendous potential in the region, several companies are following Devon's lead.
Most recently, Natural Resource Partners (NYSE: NRP ) jumped on the bandwagon, acquiring 19,200 acres in the expansive oil play. While SandRidge Energy (NYSE: SD ) and Chesapeake Energy (NYSE: CHK ) are still the largest leaseholders in the Mississippian, Devon's not far behind, with a net acreage of 230,000. The company plans on expanding operations in the region, encouraged by an initial production test rate that's among the best reported in the play.
A robust balance sheet
As for investors fretting about the expanded exploration budget, the company boasts a solid cash position. It made a ton of money after divesting a number of offshore assets in Azerbaijan, Brazil, and the Gulf of Mexico. The decision was made as part of its larger plan to focus on more profitable onshore oil and NGL production and helped the company raise more than $10 billion.
Devon closed out the first quarter with $5.8 billion in cash and cash equivalents and continues to have one of the lowest debt-to-market-cap ratios in the industry. Hefty cash reserves and a low debt load should provide a solid buffer against the increase in exploration costs.
Potential risks and the bottom line for investors
There are a few potential risks, however. Roughly $6.5 billion of Devon's cash reserves are currently overseas, where they were placed to avoid steep taxes in the United States. Of course, holding cash overseas is nothing to be alarmed about. Several major U.S. companies including Microsoft, Google, and Apple also hold vast cash reserves overseas to avoid U.S. corporate taxes.
If Devon's overseas cash reserves were repatriated, the company would have to pay U.S. corporation tax of up to 35%. However, if a bill for a temporary tax "holiday" gets passed in Congress, it would allow earnings to be repatriated at a much lower tax rate of 8.75% for a year, saving the company around $1 billion in taxes.
Overall, Devon looks well positioned and has proved time and again its adaptability to changing market conditions. The company's diversified holdings across North America should continue to provide a solid buffer in what is traditionally a high-risk industry. Management's new strategy of focusing on higher-margin liquids has already put up record production numbers, and the trend is likely to continue. In coming years, Devon appears well-positioned to bring the thunder, much like its Oklahoma City NBA counterpart.
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