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3 Risks to Watch at Devon Energy

I recently covered five reasons to love Devon Energy (NYSE: DVN  ) . As much as there is to love about this company, all investments have risks that need to be monitored. Here are three areas that Devon investors might want to watch.

It's still a bit gassy
While Devon does have a fairly well balanced production mix, that production does tilt toward natural gas. In fact the company produces more than 2 billion cubic feet of natural gas each day, which is more than 3% of all the gas consumed in North America. That's enough to rank the company fourth behind ExxonMobil (NYSE: XOM  ) , Chesapeake (NYSE: CHK  ) , and Anadarko (NYSE: APC  ) . In total, about 60% of the company's production is natural gas. 

Both ExxonMobil and Anadarko produce more liquids and respectively rank second and sixth domestically in terms of average daily liquids volume. In addition to that, both companies have operations that span the globe and operate both onshore and offshore. That diversification has helped both produce much more stable returns. Devon's operations, like Chesapeake's, are 100% onshore, though Devon has international presence thanks to its Canadian operations and a much stronger balance sheet.

To be fair, Devon's oil production was up 20% last year and its not investing any capital to grow its natural gas business. Instead, its allowing its gas production to decline and filling in that production with oil and natural gas liquids. However, some of that production is in another commodity selling at a discount.

The current commodity conundrum
You see, Devon also produces Canadian crude out of the oil sands. The problem is that the commodity, thanks to pipeline and refining constraints is cheap. That crimps its profits just like North American natural gas. 

Now, there is hope on the horizon as new pipelines are coming online and rail is beginning to pick up the slack. However, in the near term, Canadian crude is priced at a big discount to U.S. benchmark West Texas Intermediate crude oil. Having not one but two unloved commodities has hurt Devon's stock price and made it dirt cheap.

Repositioned or out of sorts?
Over the past few years Devon has repositioned the company from a global independent with operations both onshore and offshore to a focused North American onshore story. Usually, it is the other way around; only time will tell if that was the right move. 

The asset sales brought more than $10 billion into Devon's cash coffers, which it used to buy back shares, raise the dividend, and pay down some debt. It still has a little more than $7 billion in cash sitting on its balance sheet. What investors need to watch is to see if the company continues to use its balance sheet flexibility for the benefit of investors. A concern would be that the company goes out on a spending spree to move its way up the production charts simply for the sake of growth. My concerns here are very minor, but cash on the balance sheet does tend to draw attention and demands to "do something." If Devon can resist these temptations and execute on its growth plans, then investors can cross this worry off their list.

My Foolish take
While these three areas should be watched, they are not likely to keep Devon investors up at night. The management team is focused on increasing its per-share results, meaning it has investors in mind in every decision it makes. It would be nice if all companies held investors in such high regard.

While we're on the subject of management team being aligned with investors, are you watching the what's going on at Chesapeake Energy? With a regime change under way, energy investors would be hard-pressed to find another company trading at a deeper discount than Chesapeake Energy. While the the company's issues still persist, giant steps have been taken to help mitigate the problems. To learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy, and as an added bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.

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9/27/2016 4:02 PM
DVN $38.38 Down -1.26 -3.18%
Devon Energy CAPS Rating: ****
APC $58.27 Down -0.27 -0.46%
Anadarko Petroleum CAPS Rating: ****
CHK $6.23 Down -0.39 -5.89%
Chesapeake Energy CAPS Rating: ***
XOM $83.24 Up +0.18 +0.22%
ExxonMobil CAPS Rating: ****