Based in Oklahoma City, Devon Energy Corp. (DVN, Financial) is an independent oil and natural gas producer engaged in the exploration, development, and production of energy substances. Founded in 1971, its oil and gas operations are mainly concentrated in the onshore areas of North America, primarily in the United States after the sale of its Canadian business in 2019. The company’s operations are spread across the key oil assets of Delaware Basin, Eagle Ford, Anadarko Basin, Williston Basin and Powder River Basin.
After hitting a record low in 2020, crude oil prices have bounced back sharply to a seven-year high of over $90. This favorable pricing environment has enabled Devon Energy to turn profitable in 2021 following a loss-making year. The stock has gained a staggering 204% over the last 12 months on the back of this stellar financial performance, and the company seems well-positioned to carry this momentum well into 2022 amid improving macroeconomic conditions.
A record-making rebound
Devon Energy topped the list of best performers in the S&P 500 Index last year, which does not come as a surprise considering the stellar recovery of the energy sector in 2021. In 2020, the tech sector rallied as investors focused on stay-at-home winners. The tables turned last year with the energy sector outperforming the tech sector by 23%, which marks the second-biggest spread in history according to Bank of America Securities. Even on the back of this strong performance, energy stocks remain cheap at 11 times forward earnings versus an average of 17 times since 1986.
Crude oil prices rallied from around $53 to over $90 in the last 12 months along with the recovery of the global economy and the supply limitations resulting from OPEC+ production cuts. Oil demand recovered across the board with the easing of mobility restrictions. The International Energy Agency predicts global oil demand will top pre-pandemic levels in 2022. JPMorgan analysts forecast oil could hit $125 this year, in which case Devon, along with other energy companies, will have an excellent opportunity to boost profitability.
Devon is focused on long-term success
Devon Energy, in the recent past, has focused on diversifying into renewable energy in a bid to secure the sustainability of its future earnings in a world that is rapidly embracing environmentally-friendly energy sources. Today, almost half of volumes come from natural gas and liquids, a strategy that has helped the company gain the trust of investors.
To drive earnings growth, the company is focused on acquisition opportunities as well. In January 2021, Devon Energy completed an all-stock merger with WPX Energy, which is a company renowned for its high-quality energy assets. This deal will strengthen the company's position in the Delaware and Williston basins and is likely to improve the operating cash flow over the long run.
Devon Energy, despite executing planned investments in increasing its production capacity and efficiency, has been able to strengthen its liquidity position as well. Last August, Fitch Ratings upgraded the long-term issuer default rating and senior unsecured ratings of the company to BBB+ from BBB and affirmed Devon's short-term IDR and CP rating at F2, backed by the scale and economics of its Delaware and other basins, strong liquidity position and favorable leverage.
Third-quarter earnings highlight the momentum behind Devon Energy
Devon Energy reported a 224% year-over-year increase in revenue to $3.47 billion. Earnings per share were $1.08 compared to a loss of 4 cents in the prior-year quarter. Free cash flow generation accelerated to $1.1 billion, which was an eight-fold increase from the fourth quarter of 2020, and the balance sheet strengthened with the cash balance increasing by $782 million to a total of $2.3 billion.
The improving industry conditions and the strengthening balance sheet will enable Devon Energy to reward shareholders handsomely with dividends and stock buybacks. The company, historically, has shown a commitment toward distributing excess earnings to shareholders. Devon Energy employs a fixed plus variable dividend policy, which for the most recent quarter totaled 84 cents per share and was an increase of 71% from the dividend declared in the previous quarter. The variable portion of the dividend makes the forward yield highly unpredictable, but given the positive outlook for the energy industry, it would be reasonable to expect the company to positively surprise the market.
Takeaway
Global energy demand is on the rise, supported by the increasing vaccination rates, easing of travel restrictions and strong economic growth. The balanced and disciplined internal strategies at Devon Energy are likely to help the company thrive over the next several years, which could turn out to be an impressive growth phase for many energy companies with a diversified product portfolio.
