Simul-Frac Expansion And Cost Cuts Will Improve Delaware Basin Operations

Key Takeaways

• Business optimizations, including capital expenditure reductions and improved drilling efficiency, will boost cash flow and strengthen Devon's financial position.
  
• Divestitures and renegotiated contracts are set to enhance liquidity and lower costs, supporting debt reduction, profitability, and EPS growth.
  
• Downturns in commodity pricing and execution risks in cost reductions could impact Devon Energy's cash flow, margins, and shareholder returns.

Catalysts

An independent energy company, engages in the exploration, development, and production of oil, natural gas, and natural gas liquids in the United States.

• Devon Energy expects to generate an additional $1 billion in annual free cash flow by 2026 through business optimization efforts, including reducing capital expenditures while maintaining productive capacity, which would positively impact free cash flow and earnings.
  
• The expansion of simul-frac technology and efficiency improvements in drilling have allowed Devon to reduce its rig count in the Delaware Basin while maintaining production capacity, thus improving operational efficiency and potentially boosting net margins.
  
• The dissolution of the partnership with BPX in the Eagle Ford, along with significant cost reductions and efficiencies, is expected to result in $2.7 million savings per well, enhancing the return on investment, which would positively impact net income and margins.
  
• Devon's $375 million divestiture of its Matterhorn pipeline interest and potential additional midstream monetizations will further strengthen its liquidity position, enabling potential debt reduction and supporting shareholder returns, positively affecting net margins and earnings per share (EPS).
  
• The company has renegotiated midstream contracts to lower gathering, processing, and transportation costs, particularly in the Delaware Basin, expected to improve margins and cash flow from 2026, which will enhance profitability and EPS.

Devon Energy Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Devon Energy's revenue will grow by 2.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 19.1% today to 17.8% in 3 years time.
• Analysts expect earnings to remain at the same level they are now, that being $2.9 billion (with an earnings per share of $5.09). However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $4.1 billion in earnings, and the most bearish expecting $1.6 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 12.6x on those 2028 earnings, up from 6.8x today. This future PE is greater than the current PE for the US Oil and Gas industry at 11.3x.
• Analysts expect the number of shares outstanding to grow by 2.62% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.68%, as per the Simply Wall St company report.

Devon Energy Future Earnings Per Share Growth

Risks

• A downturn in commodity pricing could negatively impact Devon Energy's operating cash flow and free cash flow generation, affecting its ability to fund capital investment and return cash to shareholders.
  
• The company's reliance on efficiency gains and cost reductions to achieve its $1 billion annual free cash flow target by 2026 carries execution risk; failing to realize these savings could impact net margins and overall earnings.
  
• Market conditions and competitor actions in the oil and gas sector could limit infrastructure cost reductions and contract renegotiations, potentially affecting Devon's operating margins and overall profitability.
  
• Declining production due to reduced rig counts or inefficiencies in operations could hinder revenue growth, especially if global oil demand or prices remain weak.
  
• Geopolitical risks and regulatory changes in regions where Devon has key operations could introduce uncertainties that impact project timelines, capital costs, and future revenue projections.

Valuation

• The analysts have a consensus price target of $43.558 for Devon Energy based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $66.0, and the most bearish reporting a price target of just $32.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $16.4 billion, earnings will come to $2.9 billion, and it would be trading on a PE ratio of 12.6x, assuming you use a discount rate of 6.7%.
  
• Given the current share price of $30.59, the analyst price target of $43.56 is 29.8% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.