Falling piece by piece
Devon Energy operates conventional and unconventional oil and natural gas assets throughout the US and Canada. Management has recently announced the acquisition of additional assets from GeoSouthern Energy for $6 billion in cash, located in the eastern Eagle Ford play. The asset will add 400 billion barrels of oil equivalent to current reserves, estimated at 17.8 trillion cubic feet equivalent, or a production of 4.1 billion cubic feet equivalent per day. The figures show that portfolio is titled towards gas, more than oil production.
Devon has marketing and midstream operations, primarily in North America that will play right into the company’s business strategy to expand and develop its oil and liquids-rich assets to achieve a more balanced portfolio. For the long term, its unconventional resources assets and prolific reserves guarantee a steady production. However, the volatility of the industry may affect the overall performance due to a small international exposure.
A joint venture with China’s Sinopec International Petroleum Exploration & Production and Japan’s Sumitomo are the most important international ventures of the past time. The two ventures have helped the firm to diversify risks and reduce those associated with exploration. However, the company had to give away 30% of its working interest. Going back to domestic operations, marketing and midstream assets are a key competitive advantage.
The balance sheet for Devon Energy is weak due to negative margins and rising debt. Currently the stock trades at 14.66 times its forward earnings, carrying a 36% premium to the industry average. The trades done by gurus during the last quarter are mixed. Jean-Marie Eveillard, the guru with the largest position, registered no changes. Tweedy Browne and Charles de Vaulx, with the second and third largest stake correspondingly, increased their positions during the year. Interestingly, Renaissance Technologies increased its share through the same period. I disagree with these gurus since finances are in deep trouble.
With large positions in the Barnett, Eagle Ford, Haynesville, and Marcellus shale, Chesapeake Energy is an explorer, producer, and marketer of natural gas, oil, and natural gas liquids in the US. Through considerable drilling prowess and an acquisitions strategy, the firm has turned into the second largest natural gas producer in the US. And although production rose by 18.8% during 2012, proven reserves have fallen by 17% when compared to 2011.
Ahead, Chesapeake Energy continues to tilt its portfolio towards natural gas liquids, in order to offset declining prices on natural gas prices. Hence, 85% of the total 2013 capex will be destined to drill liquids-rich plays in the near future. The assets that will receive much of the funds are: Eagle Ford Shale, Granite Wash and Mississippi Lime. In all, for the upcoming year management expects lower operating costs and commodity prices, to be countered by higher production. This policy will be accompanied by cost cutting initiatives.
Chesapeake Energy has already made public its intention of reducing long-term debt. Management aims at increasing cash flow at the same time, so the drop of some asset and end of lease-hold spending is expected. Should the drop of assets be the road taken, the company risks losing a great potential in unconventional resources and liquid-rich plays. Last, the lack of international exposure makes the firm very vulnerable to the industry’s volatility.
Financially, Chesapeake Energy is financially weak due to negative margins and deteriorated cash flow. Currently trading in the negative side of its trailing and forward earnings, the company carries a big discount that reflects the risks associated with investing in the firm. Hence, I understand Mason Hawkins’ stake reduction, and question Carl Ichan’s position increment. I do not see important growth catalysts, and declining commodity prices questions future prospects.
Currently, both firms here analyzed present grave obstacles ahead due to declining commodity prices, and lack of strategic acquisitions to boost overall performance. Actual cash flow, debt, and revenues continue to offer management a great headache.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks
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