Devon Energy to Expand Production No Matter What OPEC Does

NEW YORK (TheStreet) -- Saudi Arabia and the 11 other oil-producing nations in the Organization of the Petroleum Exporting Countries failed to apply the brakes to plunging oil prices when it left production alone during last week's meeting

Devon Energy's (DVN)   can still post double-digit production growth and improve its profitability. Here's why.

The Oklahoma City oil and gas producer has land-based operations mainly in Oklahoma, Texas, New Mexico and in Alberta, Canada. Devon is also a majority owner of EnLink Midstream Partners LP  (ENLK)  and EnLink Midstream LLC  (ENLC) , owners of oil and gas pipelines, processing plants and storage facilities.

Like energy companies such as EOG Resources (EOG) , Chesapeake Energy (CHK) , QEP Resources (QEP) and Newfield Exploration (NFX) , Devon has been focusing on higher-margin oil production rather than natural gas. Thanks to its new focus and selling some gas operations, Devon said Nov. 14 it will increase its total oil production by more than 35% in the current year.

Since then WTI crude futures have continued their fall, touching five-year lows on Friday after OPEC said it wasn't cutting production. Devon shares fell by nearly 8% on Friday. The stock has dropped 4.5% for the year to date. 

Devon CEO John Richels said last month his company can tackle this tough market since it has one of the "strongest balance sheets" in the sector. This financial strength will be further strengthened by the expected sale of assets, or drop down, to EnLink, he said.

Goldman Sachs analyst Brian Singer, who covers the company, agrees, saying while Devon might have negative free cash flows of $800 million next year -- signifying greater cash outflows as capital expenditure than cash inflows from operations -- this can be absorbed by Devon's "strong balance sheet."

Last week Goldman Sachs released a report on the energy sector, reiterating its forecast that the market will respond to lower oil prices through a slowdown in U.S. shale production growth and supply cuts from OPEC by mid-2015. In this context, Goldman Sachs said that OPEC's next meeting on June 5 will be closely watched. Goldman still predicts WTI oil averaging between $70 and $75 a barrel in 2015, an improvement from the current levels of nearly $67 a barrel.

Scott Hanold, analyst at RBC Capital Markets, said Devon has a "robust cash position," "low debt levels" and "ample liquidity to pursue further accretive growth." During the third-quarter conference call, the CEO said Devon will achieve between 20% to 25% increase in oil production in 2015 without increasing its exploration and production budget as compared to 2014.

Brian Singer, on the other hand, forecasts 18% increase in oil production. The company will be seventh-fastest-growing oil producer in terms of year-over-year production in the final quarter of 2015, he thinks, compared with the more than two dozen Devon competitors covered by Goldman Sachs.

The increase in oil growth will also improve Devon's profitability. In a November report, Hanolds wrote for RBC that by focusing on "high-returning, oil-growth properties" the company's margins will increase by 29% in 2014, compared to an average of just 5% of its large-cap exploration and production peers. Hanold estimates  Devon's operating margins will continue to expand from $12.72 a barrel in 2014 to $14.66 a barrel in 2016.

Devon Energy's spokesperson was not available for comment. Brian Singer gave the company a neutral rating while Hanold has an outperform rating on the stock.

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

Follow @Sarfaraz_A_Khan

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
TheStreet Ratings team rates DEVON ENERGY CORP as a Buy with a ratings score of B-. TheStreet Ratings Team has this to say about their recommendation:

"We rate DEVON ENERGY CORP (DVN) a BUY. This is driven by a few notable strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its robust revenue growth, impressive record of earnings per share growth, compelling growth in net income, attractive valuation levels and expanding profit margins. We feel these strengths outweigh the fact that the company shows weak operating cash flow."

You can view the full analysis from the report here: DVN Ratings Report

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