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The Little Driller That Could (DVN)
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DVN
Based in Oklahoma City, Devon Energy (NYSE: DVN) is one of the largest independent exploration and production energy companies in the U.S.
DVN came of age in 2003 with the merger of Devon and Ocean Energy. The acquisition greatly expanded reserves, but came at a steep price as debt rose ten-fold to $8.5 billion and shares outstanding doubled.
Since that time, DVN has been selling selected underperforming assets.
In 2005, DVN sold around 14% of its proved reserves for around $2.3 billion, and used the proceeds to reduce debt and buyback shares.
In recent times, DVN has announced it is exiting West Africa and Egypt, which account for approximately 5% of its proven reserves. This strategy causes me to wonder what DNV has left.
The U.S. accounts for approximately 60% of total productio,n with Canada contributing about 25% as well. DVN also has a small but promising foothold in Brazil and Asia.
DVN reserves are 65% natural gas and almost entirely U.S.-based. The company has a solid holding in deepwater Golf of Mexico and the Barnett Shale. Devon is also one of the five largest leaseholders in Gulf of Mexico properties and is the largest leaseholder and producer in the well-regarded Barnett Shale deposit near Fort Worth.
DVN also has a stake in Canada's Alberta oil sands. DVN also has some promising projects in Brazil and Azerbaijan which will contribute around 60,000 barrels of oil equivalent per day (BOE/D) in 2007.
However, the major attraction with DVN its proved reserves and its ability to successfully find new proved reserves. DVN's proved reserves at the end of 2006 were 2.4 billion barrels, up 13% from 2005.
DVN replaced nearly 180% of its 2006 production at a cost of $13.43 per barrel from organic sources. That is an outstanding feat that rivals the performance of many large integrated oil companies. Including acquisitions, the company's reserve replacement exceeded 225% at a cost of around $15.82 per barrel. Acquired reserves were considerably more expensive at a cost of $24.43 per barrel.
Another part of DVN's strategy to increase reserves is that DVN spends heavily on capex. DVN allocates around 85% of its capex to low-risk projects in well-known fields. The balance goes to high impact projects that have elevated risk levels but offer the opportunity to add substantial reserves.
In the recent 4th quarter, Devon drilled 526 wells with a 98% success rate. That high success rate is not a one-time phenomenon -- in the 4th quarter of 2005 Devon drilled 525 wells with a 97% success rate. DVN forecasts it will spend $5.6-5.8 billion in 2007 on capex, which will increase proved reserves by 350-370 million BOE. DVN believes that, adjusted for divestitures, they will be able to grow production around 10% over the next 3 years.
On a valuation basis, Devon is selling around 10.6 times its 2007 earnings estimate. In terms of price/cash flow, it is selling at 4.7 times, in the middle of its historical range 2.8-6.5. On a PEG basis, DVN is selling at a discount to many of its peers.
DVN is not overly inexpensive based on the fundamental market measures. However, the reserves and replacement numbers are the key value metrics for DVN. With proved reserves of 2.4 billion barrels, DVN has an adjusted life index (replacement to production) of 9.1 years. The adjusted life index for its natural gas reserves is 8.9 years and 9.3 years for its oil reserves.
Valuing these reserves around current prices, Devon is selling at 4.4 times its enterprise value, a nearly 20% discounts to its peers. On a reserves basis, that makes DVN one of the cheapest energy companies regardless of size.
As well, the outlook for energy prices remains very positive. The high oil and natural gas prices will result in strong earnings. DVN will use those strong earnings to continue to reduce debt and buyback shares.
Currently, DVN has suspended its share buyback program as it is allocating its excess cash flow to repaying short term debt and redeeming maturing debt, but DVN does plan to resume its buybacks in the second half of 2007.
DVN only pays a nominal dividend for a 0.90% yield. Fundamentally, the company is repairing its balance sheet, increasing shareholder value and running a successful reserve replacement program. That makes DVN attractive to investors and larger energy companies as well.
Much larger, more well-known energy companies have not replaced production in several years and have not been as successful in drilling new holes. If new finds remain scarce and demand for production strong, DVN could be a very attractive target. For investors, DVN as an independent energy company is an attractive investment.
DVN came of age in 2003 with the merger of Devon and Ocean Energy. The acquisition greatly expanded reserves, but came at a steep price as debt rose ten-fold to $8.5 billion and shares outstanding doubled.
Since that time, DVN has been selling selected underperforming assets.
In 2005, DVN sold around 14% of its proved reserves for around $2.3 billion, and used the proceeds to reduce debt and buyback shares.
In recent times, DVN has announced it is exiting West Africa and Egypt, which account for approximately 5% of its proven reserves. This strategy causes me to wonder what DNV has left.
The U.S. accounts for approximately 60% of total productio,n with Canada contributing about 25% as well. DVN also has a small but promising foothold in Brazil and Asia.
DVN reserves are 65% natural gas and almost entirely U.S.-based. The company has a solid holding in deepwater Golf of Mexico and the Barnett Shale. Devon is also one of the five largest leaseholders in Gulf of Mexico properties and is the largest leaseholder and producer in the well-regarded Barnett Shale deposit near Fort Worth.
DVN also has a stake in Canada's Alberta oil sands. DVN also has some promising projects in Brazil and Azerbaijan which will contribute around 60,000 barrels of oil equivalent per day (BOE/D) in 2007.
However, the major attraction with DVN its proved reserves and its ability to successfully find new proved reserves. DVN's proved reserves at the end of 2006 were 2.4 billion barrels, up 13% from 2005.
Another part of DVN's strategy to increase reserves is that DVN spends heavily on capex. DVN allocates around 85% of its capex to low-risk projects in well-known fields. The balance goes to high impact projects that have elevated risk levels but offer the opportunity to add substantial reserves.
In the recent 4th quarter, Devon drilled 526 wells with a 98% success rate. That high success rate is not a one-time phenomenon -- in the 4th quarter of 2005 Devon drilled 525 wells with a 97% success rate. DVN forecasts it will spend $5.6-5.8 billion in 2007 on capex, which will increase proved reserves by 350-370 million BOE. DVN believes that, adjusted for divestitures, they will be able to grow production around 10% over the next 3 years.
On a valuation basis, Devon is selling around 10.6 times its 2007 earnings estimate. In terms of price/cash flow, it is selling at 4.7 times, in the middle of its historical range 2.8-6.5. On a PEG basis, DVN is selling at a discount to many of its peers.
DVN is not overly inexpensive based on the fundamental market measures. However, the reserves and replacement numbers are the key value metrics for DVN. With proved reserves of 2.4 billion barrels, DVN has an adjusted life index (replacement to production) of 9.1 years. The adjusted life index for its natural gas reserves is 8.9 years and 9.3 years for its oil reserves.
Valuing these reserves around current prices, Devon is selling at 4.4 times its enterprise value, a nearly 20% discounts to its peers. On a reserves basis, that makes DVN one of the cheapest energy companies regardless of size.
As well, the outlook for energy prices remains very positive. The high oil and natural gas prices will result in strong earnings. DVN will use those strong earnings to continue to reduce debt and buyback shares.
Currently, DVN has suspended its share buyback program as it is allocating its excess cash flow to repaying short term debt and redeeming maturing debt, but DVN does plan to resume its buybacks in the second half of 2007.
DVN only pays a nominal dividend for a 0.90% yield. Fundamentally, the company is repairing its balance sheet, increasing shareholder value and running a successful reserve replacement program. That makes DVN attractive to investors and larger energy companies as well.
Much larger, more well-known energy companies have not replaced production in several years and have not been as successful in drilling new holes. If new finds remain scarce and demand for production strong, DVN could be a very attractive target. For investors, DVN as an independent energy company is an attractive investment.
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