Devon Energy (NYSE:DVN) has spent the past several years reshaping its portfolio to focus on the best U.S. shale plays. The company took another step in that direction this week by agreeing to sell its remaining assets in Canada to Canadian Natural Resources (NYSE:CNQ) for 3.8 billion Canadian dollars ($2.8 billion). It's a win for both companies, as it lines up perfectly with their growth strategies.
Why the deal makes sense for Devon Energy
Devon Energy revealed earlier this year that it would pursue the separation of both its oil sands business in Canada and its Barnett Shale assets in Texas. These businesses no longer fit within Devon's core portfolio, which consists of four high-margin, high-growth U.S. shale plays: Eagle Ford, STACK/SCOOP, Delaware Basin, and Powder River Basin.
While Devon was open to spinning off its Canadian business to shareholders, it opted to sell the assets to Canadian Natural Resources for roughly $2.8 billion. That's an attractive price considering the assets produced $236 million in cash flow last year. The company plans to use that cash to pay off more debt and further strengthen its balance sheet.
In addition to improving its financial profile, the sale will remove an asset from Devon Energy's portfolio that has struggled to deliver consistent performance. In last year's third quarter, for example, the company's output from Canada came in below forecast because it had to perform extra maintenance on the facility. Meanwhile, oil prices in the country have been under pressure in recent years because of Canada's lack of adequate pipeline capacity. By jettisoning this asset, Devon will remove this volatility from its portfolio. Further, it's selling an asset that wasn't growing, since that pipeline problem meant that Devon had no plans for further development in the country.
By parting with this business, Devon can focus even more of its attention on its exceptional U.S. shale assets. The company believes these areas can deliver 12% to 17% compound annual oil growth over the next three years while generating $2.3 billion in free cash flow. That will give the company more money to continue buying back stock and increasing its dividend.
Why the deal makes sense for Canadian Natural Resources
This transaction also makes perfect strategic sense for Canadian Natural Resources. For starters, Devon's assets are adjacent to the company's existing assets in the country. As a result, the Canadian oil and gas producer believes it can consolidate facilities as well as operate more efficiently, which should enable it to capture CA$135 million ($100 million) in annual cost savings. The deal also allows Canadian Natural Resources to grow its production without adding additional volumes to the already saturated Canadian market, since this is existing production. Meanwhile, the company picks up some upside potential given that 1 million of the 1.5 million acres of land it will pick up remain undeveloped and can be developed once new pipelines enter service.
The deal also lines up well with Canadian Natural Resources' strategy to expand in its home country. The company has completed several needle-moving transactions over the past few years. In 2017, for example, it acquired a 70% interest in the Athabasca Oil Sands Project from Royal Dutch Shell and Marathon Oil for CA$12.74 billion ($9.4 billion). Meanwhile, in 2014, Canadian Natural Resources bought Devon's conventional oil and gas operations in the country for CA$3.125 billion ($2.3 billion). In both transactions, Canadian Natural Resources acquired assets near its existing position, which enabled the company to cut costs so it could maximize the value of these resources.
Canadian Natural Resources has significantly increased its scale through these transactions, which has proven to be a major competitive advantage. The company has been able to leverage its larger size to reduce costs, which has improved its margins. That's allowing it to generate significant cash flow even though, because of its pipeline issues, Canada's oil has often sold at a steep discount compared to oil in the U.S.
A great deal for both sides
Devon Energy took another step toward becoming a U.S. oil growth machine by selling the rest of its Canadian operations to Canadian Natural Resources. That will enable the company to focus on its four core shale plays, which can deliver strong production growth and free cash flow that it aims to continue returning to investors. That combination of growth and returns is why it's one of the best oil stocks to buy these days.
However, it's not the only winner in this deal, since Canadian Natural Resources picks up an asset that perfectly fits into its portfolio. Because of that, it too remains well positioned to grow its production, cash flow, and shareholder returns. That makes it an increasingly compelling oil stock to consider.