Third Avenue Management Comments on Devon Energy Corp
As discussed in last quarter's letter, a new position was initiated in Devon Common (DVN). We added modestly to the position this quarter. Devon Energy Corp. is an Oklahoma-based oil and gas exploration and production company. In April, I attended the presentation of Devon's CEO, John Rickels, at the IPAA Oil and Gas Investor Symposium in New York City. The highlight was the company's discussion of its long-term growth outlook: production is projected to increase from 240 million barrels of oil equivalent ("BOE") in 2011, to 340 million BOE by 2016, representing a 7% annual growth rate. This growth is projected to be driven by high margin oil and natural gas liquids ("NGLs") annual growth of 16% to 18%, while natural gas production declines slightly. The company should retain a very strong financial position throughout this period, as most of the growth is expected to be funded by operating cash flow (the company expects to use only $1.5 billion of its $7 billion in cash over this period).
In early May, Devon reported first quarter results that showed significant progress. The company generated 10% year-over-year production growth, driven by increases in oil and NGLs production of 26% and 21%, respectively. The company's Jackfish oil sands projects in Canada generated a 55% increase in production, while oil production in the Permian basin in Texas, which has been revitalized by the application of horizontal drilling technology, increased 32%. The primary negative factor was low natural gas prices, which declined 35% to $2.34 per thousand cubic feet equivalent ("mcfe"). Fortunately, Devon's realized price was $3.02 owing to gains from its hedges, and the company has about 40% of its natural gas production hedged at $4.42 per mcfe for the balance of the year. Devon Common's valuation is attractive at about five times earnings before interest, taxes, depreciation and amortization ("EBITDA"), a 10% discount to estimated net asset value and $10 per BOE of proved reserves. By comparison, in 2009 and 2010, the company exited its Gulf of Mexico and international operations at a price of about $45 per BOE of proved reserves. Devon Common accounted for 1.2% of the Fund's net assets at quarter end, and the position has been increased this quarter as the stock has declined.