This Natural Gas Stock Should Be a Winner

Thanks to lousy market conditions, quite a few natural gas producers have been witnessing diminishing returns over the last 12 months. In fact, for many of them, the only hope for a reversal of fortune was to wait till natural gas prices recover.

While such a recovery is by no means insignificant, E&P companies run by enterprising management were far from being bogged down by these hostile conditions. Instead, they diversified and made a foray into the more lucrative liquids production, and at the same time, cut down on unnecessary costs. Read on, and you will see why Devon Energy (NYSE: DVN  ) happens to be one such company that investors should pay attention to.

A solid business model
Primarily a natural gas producer, Devon Energy has significantly increased oil production through its properties in the Permian Basin and the Canadian oilsands in the last year. What really caught my attention has been the fact that in the second quarter, production from the Canadian oilsands was only behind that of its Barnett Shale properties.

The two Jackfish oilsands projects averaged a record oil production of 51,000 barrels per day (bpd) in the second quarter -- a solid 63% growth from last year's second quarter. And that's not all. The outstanding success has triggered the development of a third Jackfish project, which should come online by late 2014. Adjacent to its Jackfish projects, Devon is further seeking to exploit the Canadian oilsands with the Pike project, whose gross production capacity is estimated to be a phenomenal 105,000 bpd. Management, in other words, has big plans for the long term, some of which are already bearing fruit.

A company that has its priorities right
Not surprisingly, proportion of liquids production has gone up by nearly four percentage points to 37%, or 2.8 million barrels in 12 months. Not only has management invested in the right kind of assets, it has ensured proper monetization of those assets. This is in sharp contrast to the business model of another natural gas giant and Devon's new neighbor in Oklahoma, Chesapeake Energy (NYSE: CHK  ) . The latter, it seems, was more intent on amassing properties it had no intention of developing.

What really matters
As investors, it's important to keep a company's overall business and its long-term prospects in perspective, rather than panic over market conditions (which can actually turn around faster than many think). Having said that, Devon's balance sheet looks sound with cash balances of over $6 billion. Debt-to-equity stands at a respectable 48%. Cash flows from continuing operations have increased over comparative periods, and there's no reason to believe it shouldn't remain so in the coming years. Additionally, with natural gas prices showing signs of recovery, Devon should be well placed to script a success like no other natural gas producer. The company's production portfolio is now looking more balanced than ever. But somehow, the market hasn't given the company due credit.

Something Mr. Market's ignoring
Looking at Devon's huge potential as an oil producer, I've a strong suspicion that the stock could be undervalued.

Company

P/B (MRQ)

TTM P/E

Devon Energy

1.1

10.4 

EOG Resources (NYSE: EOG  )

2.3

22.2 

Encana (NYSE: ECA  )

2.4

N/A 

Source: Yahoo! Finance. MRQ = Most Recent Quarter. TTM = trailing 12 months.

Looking at these numbers and comparing them with those of its competitors, Devon looks pretty much undervalued. Investors should take note.

Foolish bottom line
Devon looks like a safe investment. With many projects expected to go online in the next couple of years, this is a stock for long-term investors. With oil prices predicted to move up, Devon's investments in liquids rich properties should be rewarding.

If you're on the lookout for some currently intriguing energy plays that should profit from rising oil prices, check out The Motley Fool's 3 Stocks for $100 Oil. You can get free access to this special report by clicking here.

Fool contributor Isac Simon has no positions in the stocks mentioned above. The Motley Fool owns shares of Devon Energy and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, short JAN 2014 $15.00 puts on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on 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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