Devon Energy Stock Will Continue Its Impressive Rally. Here's Why

NEW YORK (TheStreet) -- Unlike some of its peers, Devon Energy (DVN) has been slow to shift from natural gas to oil, but it is quickly catching up.

The company is selling its noncore assets and is using the proceeds to fuel its growth in liquid fuels. Despite the asset sales, the company is eyeing double-digit growth in its oil production in the coming years, which will drive margin expansion and cash flow growth.

By the end of this year, Devon has forecast that its production will be 40% oil and 20% natural gas liquids, a significant shift from a few years ago when 70% of its production was natural gas.

Devon also a majority owner of a midstream master limited partnership, EnLink Midstream (ENLC) (ENLK), which stands to benefit from the shale boom.

EnLink's assets include more than 7,300 miles of pipelines, 12 processing plants and six fractionators. EnLink has operations in most of the oil and gas producing regions of North America, including the Permian Basin, Eagle Ford, Gulf Coast, Utica and Marcellus Shales. The MLP will benefit from the increasing oil and gas production from these regions.

Devon's debt-to-equity ratio is higher than the industry's average of 51%, but investors shouldn't worry because the company will shore up its balance sheet with upcoming asset sales and increased cash flow. The company has forecast double-digit growth in cash flows in the coming years.

Devon's shares are up more than 20% this year and are currently changing hands at around $75, yet they are priced just 13 times this year's earnings estimates, according to data compiled by Thomson Reuters. The shares are likely to continue going higher on the back of increasing oil production.

Last year, the company announced the expensive purchase of GeoSouthern's assets in Eagle Ford for $6 billion in order to grow its oil production in the the lower 48 states. The assets hold estimated reserves of 400 million barrels of oil.

Devon has been transforming into a North America-focused onshore energy company by selling its domestic and international assets.

This year, Devon sold most of its Canadian conventional assets to Canadian Natural Resources (CNQ) for $2.7 billion.

Since these assets are noncore, it is unlikely that the sale will have any significant impact on the company's growth targets, which are largely based on its oil-weighted core acreage.

Devon is now focusing on five core areas, of which three -- Canadian oil sands, Permian Basin and Eagle Ford -- are oil-weighted. In the previous quarter, the company reported a 21% year-over-year increase in production from these assets.

Devon also has noncore operations at Mississippian Woodford and the Rockies. The company is currently testing this acreage to ascertain its true potential.

In 2014, the recently acquired Eagle Ford assets will give a boost of around 75,000 barrels of oil equivalent per day to Devon's annual output, of which more than 75% is going to be oil and natural gas liquids. Moreover, starting next year, these assets will start generating $800 million in annual cash flows.

Overall, in 2014, Devon is targeting more than 30% growth in oil production from its assets in North America to more than 198,000 barrels per day. This will be driven by a more than 70% increase in output from the U.S, mainly from the Permian Basin and Eagle Ford.

Although the production from Canada will be largely flat this year, the company is eyeing growth from next year when its Jackfish-3 project comes online.

Over the long term, the company says that it can increase its annual production by more than 20% for the next several years. With increasing oil production, Devon will expand its margins and grow its cash flows.

Interestingly, Devon has not completely given up on natural gas. If the gas prices increase, then the company can tap into its gas-rich core assets in Anadarko Basin and Barnett Shale.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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