Giving Devon Energy Another Look

 | May 20, 2013 | 12:00 PM EDT
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Domestic large-cap oil and gas companies have made a lot of moves over the last year or so to unlock shareholder value and bolster growth.

Many have sold overseas assets to concentrate on growing their rapidly expanding North America production. They have also increased how much of their production comes from oil & liquids. Others have spun off or discontinued non-core operating assets and many have been increasingly targeted by activist fund managers.

Over the last year ConocoPhillips (COP) spun off its refinery assets via Phillips66 (PSX), which has doubled in its thirteen months as a public company. Hess Corporation (HES) is up some 40% over the last six months driven by the changes it has made prodded by activist fund manager, Elliott Management. Even serial laggard Occidental Petroleum (OXY), pushed by shareholders, recently booted its longtime president and chairman off its board . I have been fortunate enough to have benefitted from all these moves within the portion of my portfolio I allocate to energy holdings.

One energy concern that does not seem to get much attention despite its over $20 billion market capitalization is Devon Energy (DVN). It has the three characteristics I look for in making a new investment in this space -- growth, valuation and catalysts.

Growth -- Revenue growth is projected to post gains of 7% to 8% this fiscal year before doubling to over 16% in FY2014. The company reported 14% oil production growth Y/Y in the first quarter as it continues to increase the amount of production it gets from oil & liquids. The company has a deep inventory of development opportunities, of highly visible oil production growth and of solid positions in emerging oil plays (Permian, for example).

Valuation -- Devon is priced at better than a 50% discount to its peer group based on enterprise value divided by flowing barrel of oil equivalent -- Credit Suisse. Using more traditional metrics, DVN is selling at less than 12x 2014's projected earnings and just 20% over book value. The shares also pay a 1.5% dividend. The company has bought back 20% of its float since 2004 and has also raised its dividend at a 24% compound annual growth rate over that time frame as well. The company has 3 billion of barrels of oil equivalent in proved reserves (47% oil & liquids).

Catalysts --  Given that 60% of Devon's production is natural gas, the rise of natural gas prices that has occurred over the past six months is beneficial to the company's valuation/long-term profits. The company is expected to make an announcement of what it intends to do with its midstream assets soon. Several large shareholders have advocated that the company spin these assets as an energy master limited partnership to help unlock shareholder value. These assets are expected to contribute $400 million to $500 million in operating profit in 2013. Given some comments recently from management, this move seems likely. During its last conference call, the company commented that it is using a tax efficient structure to repatriate $2 billion of its overseas cash home at mid-single digit tax rate.

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