While production problems at the end of 2017 caused Devon Energy (NYSE: DVN) to miss the mark in the fourth quarter, the company quickly turned things around in 2018. Because of that, CEO Dave Hager is very optimistic about this year, which was evident in his comments on the accompanying conference call where he had four key messages for investors.
1. We're outpacing our expectations
"The first key message," according to Hager, "is that we are raising our 2018 guidance for U.S. oil production due to the outstanding operational performance we are experiencing in the Delaware and STACK." One of the highlights during the quarter was that the company drilled two of the best wells ever completed in the Delaware Basin. Because of strong well results like that, the company now sees oil production in the U.S. growing 16% this year at the midpoint of its forecast, up from an initial view that it would increase 14%.
Another factor playing a role is that the company is executing its drilling projects "with greater efficiency than planned," according to Hager, "which is compressing cycle times and pulling forward incremental activity into 2018." Because of that, he did note that "upstream capital spending will trend toward the top half of our full-year guidance range, benefiting our production profile in 2018 and 2019." However, he stated that "I want to emphasize the only reason capex is trending toward the top end of guidance is because we are completing our plan 2018 program quicker than anticipated. And we will most likely accelerate some 2019 program into 2018. This is a good news story!"
2. We have everything we need to achieve our growth strategy
"The next key point," Hagar continued, was that "we have the marketing arrangements and supply chain in place to deliver on our growth plans." That's important because with oil prices and production rising, the industry is facing shortages for pipeline capacity as well as services and equipment. However, Hagar pointed out that Devon has already secured space on the Longhorn Pipeline to get its oil to the Gulf Coast. Further, he said that while the "service market is certainly tight right now" Devon has "proactively secured rigs, supplies, and pressure pumping services in our high-activity basins at competitive prices to execute our capital plans in 2018 and 2019." Because of that, "Devon is in great shape to deliver on our growth initiatives." That's especially noteworthy given the level of inflation some peers have experienced, which Devon has helped mitigate by being proactive.
3. We're on pace to produce a gusher of cash flow in 2018
"The third key message," said Hager, "is that Devon will efficiently grow cash flow through the remainder of 2018." He noted that at current oil and gas prices, "we expect to increase our upstream cash flow by approximately 35% by year end compared to first quarter levels." He detailed three factors that will fuel this growth:
- "An increase in higher margin oil production in the U.S., where we are on pace to deliver exit-rate growth of approximately 30% in 2018."
- "Higher margins in Canada over the remainder of 2018 due to WCS (Western Canadian Select) prices recently improving by more than $10 per barrel compared to the lows experienced in Q1."
- "The aggressive steps we are taking to improve our cost structure."
That surge in cash flow is important for two reasons. First, it will give the company more money to allocate on behalf of shareholders to create value. Second, the market values companies on their earnings growth, which sets Devon up for a potential valuation boost in the coming year.
4. We're returning a growing portion of that windfall to investors
"My final key message," Hagar stated, "is that we successfully advanced several shareholder-friendly initiatives during the quarter." He pointed out that the company increased its dividend 33% and authorized a $1 billion share repurchase program that it expects to complete by year-end. He further said that "looking ahead, as we generate free cash flow from operations and asset sale proceeds, we will continue the return of cash to our shareholders through our share repurchase program and growth in the dividend." That buyback could be a big needle-mover for investors given the impact similar programs have had on the stock prices of its peers.
Hager then drilled down a bit into Devon's asset sale plan. He said that while the company could monetize more than $5 billion of assets in the coming years, he wanted to make one thing clear: "we are not going to become a Delaware and STACK pure play." Instead, it's "targeting a more focused asset portfolio." The key for Devon is to concentrate on the assets it believes can create the most value for investors going forward, even if they're outside of its two core growth drivers.
Just getting revved up
While Devon Energy stumbled heading into 2018, the company has quickly gotten back up on its feet. Because of that, it's on pace to increase production and cash flow at a healthy pace this year, while returning a significant portion of the excess to investors. That's the recipe for creating substantial shareholder value, especially considering how cheap the stock is these days.
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