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  1. Home
  2. / Investing
  3. / Energy

Devon Energy's New Strategy Is Paying Off

Buy this E&P on any pullback to around $35.
By DANIEL DICKER Jun 06, 2016 | 11:15 AM EDT
Stocks quotes in this article: EOG, DVN

We've been singularly focused on accumulating great U.S. exploration and production oil stocks, and we are ignoring the noise from another failed OPEC meeting and countless analysts who continue to suggest that the oil rally, even as it hovers below $50, is unsustainable. 

We know that oil companies -- at least those with balance-sheet problems that nonetheless stubbornly continue to increase production despite the debt risks -- won't be able to survive this oil bust, even as it rallies to $60, or even $70. So we have isolated the 'smart' E&Ps, like EOG Resources (EOG), that focus on prime production that is irrespective of oil price, and we should be willing to buy them here -- near $50 oil -- or even higher. 

So what about a company that's got superb acreage and great growth potential, that is finally seeing the light on this correct, 'EOG-type' strategy of asset sales, conservative production growth and capital conservation? One that has finally decided not just to 'talk the talk' but also to really 'walk the walk,' with the asse sales of over $1 billion announced today and the promise of $2 billion more, is Devon Energy (DVN). I believe Devon is finally acting like the kind of energy company that is worthy of your investment dollar. 

We have heard CEO David Hager speak, on his quarterly calls, as a fiscal conservative focused on maintaining a strong balance sheet. But the actions from Devon for much of 2015 and the start of 2016 have not really shown that to be true.

Devon chased oil production in 2015, increasing it by almost 30%. Debt increased hand in hand with production growth -- by more than $1.5 billion. In addition, Devon spent almost $2 billion last December acquiring more acreage in its core, Oklahoma STACK play from E&P Felix Energy. This strategy certainly increases growth potential, but it is at odds with the 'conservation strategy' that Hager claimed to be following. 

These moves had kept me wary of recommending Devon, despite its superior assets in the Anadarko and Eagle Ford shale plays. But recent moves to finally hold the line on production, for the benefit of the balance sheet, have me more confident in adding Devon to a core E&P portfolio. 

First, capital expenditures were cut 75%, to $900 million, and first-quarter reports have Devon holding that line on spending. Second, the dividend was equally slashed by 75%, saving $300 million a year. Finally, today's announcement of the sale of noncore Anadarko assets in the Granite Wash and in the Eagle Ford for around $1 billion have come in well ahead of schedule, with a promise of a further sale of 50% of the downstream Access pipeline to come. 

This is the kind of action that I have been waiting for from Devon. We can't expect bottom-line growth with these kinds of moves in the near future, but what Devon is finally doing is planning for the long haul of lowered energy prices, with a long-term, slow and sustainable production growth profile when oil prices again reach above $60, $70, $80 and higher.

The company has come to realize that a weak balance sheet cannot be easily sustained, even as oil prices move higher, and Devon is preparing for the long term, eschewing fast-track production and faster-track stock-price growth.

Even with this more-conservative approach that Wall Street is supposed to dislike, Devon has already nearly doubled from the lows it hit back in February. But as a stock that often flirted with $75 when oil was healthy, DVN has not reached its potential.

Following this more-conservative plan, we should expect Devon to now easily survive whatever period of low oil prices are yet to come, and be capable of steadily increasing production and profitability at every stage of oil's rise. 

That's the kind of stock we've been continually looking to buy. I'm recommending Devon on a pullback of any kind to near $35. 

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At the time of publication, Dicker was long EOG, although positions may change at any time.

TAGS: Investing | U.S. Equity | Energy

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