Oil prices are the talk of Wall Street now that Q3 earnings season has come to an end. WTI is above $85, at fresh 2023 highs, as Brent approaches $90. While many sell-side analysts have assumed an oil price in the $70s to low $80s, any bump up toward $90 or even $100 could lead to a slew of earnings upgrades and higher multiples across the low-P/E Energy sector.
WTI Jumps to Fresh YTD Highs
According to Bank of America Global Research, DVN is an independent energy company that explores for, develops, and produces oil, natural gas, and natural gas liquids in the United States. It’s a diversified large-cap US E&P company with fourth-quarter 2022 daily production was approximately 315,000 barrels of oil, about 150,000 barrels of natural gas liquids and more than 1 billion cubic feet of natural gas. It operates in Delaware, Anadarko, Williston, Eagle Ford, and Powder River Basin.
The Oklahoma-based $33.9 billion market cap oil and gas exploration and production industry company within the Energy sector trades at a low 7.2 trailing 12-month GAAP price-to-earnings ratio and pays a fixed and variable dividend, currently at a 3.7% forward yield if we extrapolate forward the most recent dividend announcement. Ahead of earnings at the end of next month, the stock has a modest 25% implied volatility percentage and a short interest of just 2.2%.
Back in early August, the company issued a somewhat soft Q2 report. Operating earnings per share verified at $1.18, a one-cent miss, while quarterly revenue came in 39% lower than year-ago levels – a modest miss. The good news was that its oil production reached an all-time high of 323,000 barrels per day in Q2 and the firm declared a fixed-plus-variable dividend payout of $0.49 per share based on the results. In all, it was a lukewarm report, and reduced natural gas prices undoubtedly dinged profits while share buybacks were a help.
Free cash flow was about what analysts were expecting and the management team maintained its full-year capex and production guidance. The firm continues to aim to return up to 50% of its free cash flow to shareholders via dividends and share repurchases, though I imagine we might see a lower dividend rate compared to history with more of a buyback focus. Then in mid-August, analysts at Mizuho removed Devon from its top E&P picks but kept the Energy name as a buy.
Key risks to the bullish thesis include any downward moves in oil and gas prices, which would hurt margins and free cash flow. Moreover, firm-specific delays in upstream projects could result in Devon not meeting its production targets. Higher capex expenses could bite into free cash flow and possible shareholder accretive activities.
On valuation, analysts at BofA see earnings falling sharply this year after oil’s boom in the first half of 2022. Per-share profits are seen as normalizing near $6 over the out years with robust growth. The Bloomberg consensus forecast is about on par with what BofA projects. Dividends, meanwhile, are expected to rise at a steady pace despite the variable feature of the payout. With decent free cash flow per share, currently just $1.65 on a trailing basis (though it should rise over the coming periods), and a low EV/EBITDA ratio, DVN has attractive earnings multiples.
Devon: Earnings, Valuation, Dividend, Free Cash Flow Forecasts
If we apply a sector median P/E ratio to the stock and assume normalized next-12-month EPS of $6 then shares should be near $65. Given higher oil prices today and the reality that DVN has a 5-year average operating earnings multiple closer to 13, a slightly higher valuation is warranted. Thus, if we use an 11 or 12 multiple, then shares should be in the $66 to $72 range, making it a buy.
DVN: Mixed Valuation Picture, Still Cheap On a P/E Basis
Compared to its peers, DVN has less favorable valuation grades, but it still appears cheap in my view, particularly considering its free cash flow track record and robust profitability. As earnings normalize, the growth rating should improve in my view. Still, earnings have been a bit shaky this year versus expectations, so I would like to see better execution on that front.
Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q3 2023 earnings date of Tuesday, October 31 AMC. Before that, DVN trades ex-div on September 14. No other volatility catalysts are seen on the calendar.
Corporate Event Risk Calendar
The Technical Take
Since I last reviewed Devon in the first half of the year, there have been some interesting developments. Notice in the chart below that a symmetrical triangle has taken shape. Now, typically this is a continuation pattern, indicating that DVN should eventually break down lower, but there are some reasons for optimism.
First, the RSI momentum indicator at the top of the graph has generally been trending higher after notching a low back in March. Also, if the stock can climb above the falling 200-day moving average, currently just under $55, that would help support an upward move and it would also be a breakout from the triangle/coil pattern. With a high amount of volume by price under the closing price last Friday, there should be some support down to about $49. Thus, we have a price point to monitor.
Overall, the chart is by no means a screaming buy, but long with a stop under the August low could work, and ultimately, I would still like to see DVN rise above the $56 level I noted back in May.
DVN: Concerning Symmetrical Triangle/Coil Pattern
The Bottom Line
I reiterate my buy rating on DVN stock. I continue to like the valuation, but the chart has not yet come around as much as I would like. Perhaps the move up in oil that has been ongoing can give shares a boost and a breakout.