The 2 Most Important Takeaways From Devon Energy's First-Quarter Earnings

Devon Energy’s first-quarter results show that its strategy of focusing on high-margin liquids drilling is paying off in spades.

May 12, 2014 at 2:13PM

Devon Energy (NYSE:DVN), the Oklahoma City-based independent oil and gas producer, reported strong first-quarter results last week that saw adjusted earnings surge 103% year over year to $547 million, or $1.34 per share, handily beating analysts' expectations by $0.07 per share. Here are two takeaways from the company's first-quarter results that struck me as especially important.

Linn Energy Permian

Photo credit: LINN Energy LLC.

Higher oil production fueling strong margin and cash-flow growth
Devon's first-quarter performance highlighted the continuing success of its new strategy, which is focused on boosting high-margin liquids production while curtailing dry gas drilling. First-quarter oil production grew 21% year over year to average 176,000 barrels per day, led mainly by exceptionally strong growth in domestic U.S. oil production, which jumped 56% over the first quarter of last year.

As a result of this impressive growth in oil production, margins and cash flow improved dramatically. Devon's first-quarter operating margins increased by a whopping 54% year over year, which, along with improved price realizations, drove a 41% year-over-year increase in operating cash flow, which came in at $1.4 billion.

Reflecting the company's high degree of confidence in continued strong cash-flow growth, Devon boosted its quarterly cash dividend by 9% to $0.24 per share. The raise marks the company's ninth dividend increase since 2004 and represents an annual compound dividend growth rate of 23%.  

Significant free cash flow in 2015 and beyond
Devon also continues to make good progress in high-grading its portfolio through recent moves including the acquisition of oil-rich assets in the Eagle Ford, the divestment of gas-rich acreage in Canada, and the completion of its EnLink Midstream combination.

The main strategic benefit of the company's portfolio high-grading is to position it for continued high-margin oil production growth in the years ahead. While companywide oil production is set to grow by more than 30% in 2014, Devon has a number of tricks up its sleeve to ensure that oil production growth continues at a robust pace into 2015 and beyond.

Post-2015 oil production growth will be led primarily by the Eagle Ford, the Delaware Basin, and the start up of Devon's Jackfish 3 facility in Canada. For instance, Eagle Ford production volumes are expected to average more than 100,000 boe/d from 2015 onward, while 2015 net oil production from Jackfish is expected to increase 30% to a range of 62,000-67,000 boe/d. What's even better about these projects, however, is that they will usher in a period of significant free cash flow generation after 2015.

Assuming $90 WTI prices and $4.50 Henry Hub gas prices, the company's Eagle Ford operations are expected to generate more than $1 billion in annual free cash flow in 2015 and beyond, while Jackfish is expected to generate $600 million of free cash flow in 2015 and more than $1 billion in annual free cash flow through the end of the decade.

Needless to say, all this excess cash will further bolster Devon's already robust balance sheet, providing it with unparalleled financial flexibility to fund additional capital spending, pursue acquisitions, and fund dividend payments and share repurchases.

Investor takeaway
Overall, Devon turned in another fantastic quarterly performance, showcasing its continued success in growing oil production and boosting margins and cash flow, executing on value-accretive transactions, and positioning itself for continued growth in the years ahead. Though the market is slowly starting to recognize Devon's massive potential, the company still appears significantly undervalued.

Taking out the value of its EnLink securities from its enterprise value, Devon's E&P business is trading at just over 4 times EBITDA, a hefty discount to its peers. Given the company's strong prospects for oil production, earnings, and cash flow growth, combined with its fortress-like balance sheet and world-class management team, it deserves a much higher multiple.

Will this stock be your next multibagger?
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Arjun Sreekumar owns shares of Devon Energy. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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