Production Problems Caused Devon Energy Corp to Miss the Mark in Q4

While Devon Energy (DVN +3.26%) had no problems shrugging off Hurricane Harvey in the third quarter, it wasn't able to brush past some production issues in the fourth. Two separate problems caused its output to come in under the low end of its guidance range, which resulted in earnings missing analysts' expectations by a mile. That said, these were temporary problems and will have no impact on the company's ability to grow production and cash flow at a brisk pace in the coming years.

Drilling down into the results

Data source: Devon Energy. BOE/D=barrels of oil equivalent per day.

Image source: Getty Images.

The first factor driving the underperformance was that 50 wells operated by partners in the STACK shale play didn't come online when Devon expected. That timing resulted in about 6,000 barrels per day getting pushed into early 2018 when those wells came online. In addition to that, production at the company's Jackfish complex in Canada came in under the low point of its guidance range due to some unplanned maintenance that curtailed production by 5,000 barrels per day.

Those issues in areas outside of the company's control masked the strong performance of its drilling operations during the quarter. For example, the company completed 30 high-rate wells that delivered average 30-day initial production rates of 2,500 BOE/D. Those strong wells were the continuation of an exceptional year for the company's drilling operations, which delivered the best well productivity in its 46-year history.

Meanwhile, the company produced $725 million in operating cash flow during the quarter, pushing its full-year total to $2.9 billion. That's 94% higher than 2016, thanks to a combination of higher commodity prices, a shift toward higher-margin production, and lower costs.

Image source: Getty Images.

A look at what's ahead

Devon Energy believes it has reached an inflection point where it can deliver fast-paced growth within cash flow for years to come. In 2018, for example, the company expects to boost oil output from its core STACK and Delaware Basin regions by 35%, which it can self-fund with cash flow at $50 oil. That said, with crude currently in the $60s, the company is generating free cash flow, which should only increase in the coming years.

Under the company's current three-year plan, dubbed its 2020 vision, the oil producer should generate more than $2.5 billion in free cash flow. In addition to that, the company could add more cash to its coffers by potentially selling $5 billion of non-core assets in the coming years, which is well above the $1 billion asset-sale program it unveiled last year.

Devon said it initially plans to use this cash to pay off another $1.5 billion in debt in 2018. However, after it reaches that goal, the company expects to "return excess cash flow from operations or divestitures to shareholders through both opportunistic share buybacks and dividend growth," according to CEO Dave Hagar.

That approach lines up with what rivals are planning to do, though many have already announced their initial steps to begin returning more cash to shareholders. Diamondback Energy (FANG +2.76%), for example, recently took its "first step toward rewarding shareholders for their support of our growth these last five years by initiating" a quarterly dividend, according to CEO Travis Stice. Diamondback's CEO stated that his company would be "opportunistic through multiple avenues to maximize shareholder returns," which could eventually include a buyback.

Meanwhile, Hess (HES +0.00%) is taking a slightly different approach by using its current cash pile from asset sales to pay off $500 million in debt and repurchase $500 million in stock this year. Further, Hess' CEO noted on the most recent conference call that it could add to its buyback authorization once it gets more visibility on oil prices and the cost of a major offshore-development project.

With a growing number of peers announcing increased cash returns for shareholders in 2018, Devon's under a bit of pressure to follow their lead -- especially since shares have declined more than 20% over the past year, even though production, cash flow, and oil prices are all much higher.

Don't let the headline numbers fool you

While Devon Energy's fourth-quarter results came in well below expectations, that doesn't diminish the fact that the company is transforming into a cash-flow machine. With Devon on pace to generate $2.5 billion in free cash flow over the next three years, it could, for example, potentially buy back more than 10% of its shares outstanding at the current price. Add in the potential proceeds from future asset sales, and Devon Energy could create big-time value for investors willing to embrace the company's vision for the future.