The case for undervalued energy, looking at Devon Energy over the last three years.
- The chart shows the performance of oil and gas exploration company DVN over the last three years
- Since the stock’s trough in October of 2020, it has exploded higher, rising 242%
- As explained in our white paper, quick take, our piece about the contrary indicator flags from magazine covers, and our review of the IEA “NetZero 2050” report, we have been bullish on energy
Is Devon a BUY despite the recent run?
Please click here to see why our ranking model likes the stock and some simple reasons Devon Energy, a company focused on the exploration, development, production, and transportation of oil, gas, and NGLs, may be a great candidate for due diligence.
Behavioral finance documents the unfortunate tendency of investors to sell their winners too quickly and hang on to their losers. We believe Devon is a “breakout” name that may have more room to run.
Is Devon Energy an Inexpensive World-Class Company?
The chart below shows the same chart as the one above. The only difference? The chart below shows Devon Energy’s price performance relative to the S&P 500 over the last three years. Despite the massive run since October, it has still underperformed severely.
How badly has the stock underperformed? The chart below shows that if the S&P500 just stayed flat, Devon Energy would have to rise 115% to merely catch up with the broad index.
The data below is our Single Company Tear Sheet for Devon. For all numbers, higher is better. The basics:
- Valuation Quintile 4: the stock is dirt cheap on price to book, sales to EV, and its FCF/EV is in the 71st percentile as the stock generates a 4.4% FCF/EV – as documented in our last white paper and the stunning chart in this quick take, FCF may be headed higher soon
- Balance Sheet Quintile 4: the stock is in the 90th percentile of the change in capex to total assets and the 98th and 97th percentile of Dividend growth over the last 1 and 3 years, respectively
- Earnings Quality 3: while the stock has terrific scores on accruals and margin growth, overall the business’ gross margins and ROA/ROEs are mediocre but on the mend
Devon has high Valuation and Balance Sheet Quality scores. We believe investors should be interested in a sector that has never seen lower representation in the S&P500. Read on to see some notes from the firm’s shareholder presentation and find other resources on Devon Energy.
Devon, Oil, Inflation & a High Dividend Yield:
Based on our research, we believe the aversion to oil companies has made energy a compelling opportunity.
As explained in our piece on the IEA “NetZero 2050” report, we believe investors have very mistakenly written off oil. As parents, we share the concerns that climate change presents to the world.
Energy stocks can be risky due to macro exposure. A resurgent Covid variant or aggressive production from the OPEC+ countries are among the risks. Fortunately, energy stocks have a history of protecting investors during periods when inflation rises.
Our study of high inflation during the 1970s showed that energy stocks are a critical asset class investors need exposure to. We believe that in a period of rising prices Devon’s dividend payments makes it a hedge against rising prices of goods and services.
Devon has had a dividend payout for 28 straight years. A portion of the dividend is at a fixed rate, and then a supplemental distribution is determined based on the firm’s FCF generation. The dividend dates are paid on a regular schedule so the incremental amount comes on a regular cadence.
The following make Devon an interesting candidate for investment in our view:
- world-class management
- a commitment to controlling volume growth
- a focus on cash generation, dividend payments and debt reduction
- potentially powerful protection against inflation
Below we added some text in bright green to select slides from their investor presentation. Any time you see “KCR: WORDS” that is the KCR research team – NOT the company!!
Devon Investor Presentation 2021:
Collapsing costs, capital discipline & rising output = lots of money for investors:
Devon is becoming a cash printing press:
DVN Dividend: Fixed + Variable = Honest Commitment to Paying Owners
Inflation Hedging: Devon has cash-flow pass through via the highest yield
Investment-grade balance & getting stronger = long-term winner in our view:
They are working to win the hearts & minds of the ESG crowd:
We Need Oil & Gas and Believe This Chart Has a Powerful Message:
BRIEF EXCERPTS FROM DEVON’S Q2 EARNINGS CALL:
Rick Muncrief, President and CEO:
We also possess the top ranked yield in the entire S&P 500 index by a wide margin. At today’s pricing, our yield is more than 7-times higher than the average company that is represented in the S&P 500 index.
Our dividend is comfortably funded within free cash flow and is accompanied by a strong balance sheet. Devon offers a truly unique investment opportunity for the near zero interest rate world that we live in today.
We have no intention of adding incremental barrels into the market until demand-side fundamentals sustainably recover.
Clay Gaspar, Chief Operating Officer:
The rates of return at Cotton Draw and Stateline are projected to approach 200% at today’s strip pricing.
We must also deliver our products in an environmentally and commercially sustainable way. We are committing to taking a leadership role by targeting to reducing greenhouse gas emissions 50% by 2030.
Jeff Ritenour, Chief Financial Officer:
Our dividend framework is foundational to our capital allocation process, providing us the flexibility to return cash to shareholders across a variety of market conditions.
In the second quarter, we retired $710 million of debt, bringing our total debt retired year-to-date to over $1.2 billion. This balance sheet strength is absolutely a competitive advantage for Devon and optimizes our financial flexibility through the commodity cycle.