Can Devon Energy’s Impressive Run Continue?

Devon Energy's acquisition and divestment plan has worked to perfection for the company, but as the next phase of cutting debt comes into play, can the stock soar even higher?

Jul 8, 2014 at 10:03AM

Source: Devon Energy

Devon Energy (NYSE:DVN) has undergone a fundamental transformation with countless large acquisitions to put it on par with the likes of EOG Resources (NYSE:EOG) while completing significant divestments involving explosive growth companies such as Linn Energy (NASDAQ:LINE). While this approach has sent Devon shares soaring from $55 to $80 over the last year, the big question for investors is whether this remarkable run can continue. 

Getting rid of billions in assets
In the last few months alone, Devon Energy has sold Canadian and non-core U.S. assets for more than $5 billion and last Sunday added another divestment to the mix with a $2.3 billion sale of U.S. non-core oil and gas properties to Linn Energy. The latest sale removes roughly 900,000 acres of total land in various regions. Linn Energy gains 4,500 wells and claims there are at least 1,000 more future drilling locations from the purchase.

Linn Energy is an up-and-coming mid-cap oil and natural gas company that's expected to grow revenue 60% in 2014 alone. Therefore, the well-established fundamental benefit that this acquisition will create combined with the potential for new drilling sites could help the stock soar higher.

Divesting while strategically investing
To many it may appear that Devon lost a key and valuable asset, but the divestment was all part of the company's plan to focus on core areas with the most potential per cost. In other words, Devon wants to get the most bang for its buck with assets. The company has been strategically entering the best regions in the country. Specifically, it paid $6 billion for 82,000 acres in the Eagle Ford, an acquisition that is expected to increase production by more than 20% this year alone.

Devon Eagle Ford

With just 82,000 acres acquired, such a boost to production is impressive, as this is a company that owns roughly 1.3 million acres in the Permian alone and with large presences in other regions like The Bone Spring and Delaware Basin. In looking ahead it does appear that Devon's operational strategy has been effective, as analysts project that revenue will grow 40.7% and 10.8% over the next two years, respectively. Clearly the accelerated growth in 2014 can be traced to its Eagle Ford presence, while future double-digit growth will be created from drilling opportunities and the monetization of its diversified and strong acreage portfolio.

What to like and dislike?
With all things considered, Devon has crossed over to being a growth company within this space, on a similar level to Wall Street favorite EOG Resources, which is considered by many to have the strongest position in the Eagle Ford.

Yet, EOG Resources trades at nearly 20 times forward earnings with expected revenue growth of 18% and 7% over the next two years, respectively. Hence, Devon is not only growing faster but is also cheaper on a stock multiple basis. Not to mention, Devon's operating margin of 26.3% is nearly 100 basis points greater than EOG Resources'.

So why is Devon trading at such a discount, and does it present an investment opportunity? If you look solely at its recent move into the Eagle Ford combined with existing assets and its P/E multiple, then the answer would be yes. However, the company still has high debt exposure, which has been a key concern of analysts and investors alike.

For example, EOG Resources and Devon are expected to finish 2014 with revenue of $17 billion and $14.6 billion, respectively. While EOG Resources is clearly larger, the two companies are comparable on a size basis. Yet, Devon's $15.5 billion in total debt is nearly three times larger than EOG Resources' debt, which might serve as the reason why the latter is considerably more valuable as a company.

Nonetheless, Devon Energy's acquisition initiatives are clearly intended to boost growth, while its divestments are intended to rid the company of assets that could potentially become liabilities to its long-term plan. As a result of these divestments, Devon is then able to pay off debt; and in part due to Linn Energy's recent acquisition, the company expects to reduce its net debt position by $4 billion to end this year.

Foolish thoughts
In retrospect, Devon Energy then becomes much more attractive as an investment opportunity, having growth, margins, and an attractive valuation with less risk due to a reduced debt position. In other words, all signs point to Devon Energy's remarkable year continuing, and this is a company that should get even stronger in the years ahead.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and EOG Resources. 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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