Dissolution Of BPX Joint Venture Will Lead To Improved Operational Efficiencies

Key Takeaways

• Operational efficiencies and asset integrations are driving cost savings, improving well returns, and positively impacting net margins and free cash flow.
  
• Strategic stock repurchase and dividend increase reflect confidence in stock undervaluation and aim to boost earnings per share.
  
• Operational and strategic challenges related to joint ventures, capital allocation, and regional dependencies could impact Devon Energy's margins, leverage, and revenue diversification.

Catalysts

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

• The dissolution of the JV with BPX in the Eagle Ford is expected to save Devon Energy more than $2 million per well through improved well design and operational efficiencies, enhancing returns and boosting net margins.
  
• Operational efficiencies, especially in the Delaware Basin, including improvements in drilling speed and completion efficiencies, are projected to continue in 2025, leading to higher well returns and increased free cash flow generation, positively impacting net margins.
  
• The integration of Grayson Mill assets with the Rockies team has already led to $50 million in capital and expense savings, with potential for further operating expense reductions, which should support net margin improvement going forward.
  
• The company's decision to repurchase $300 million of Devon stock and the increase of the fixed dividend by 9% indicates confidence in the undervaluation of their stock, aiming to boost earnings per share (EPS).
  
• The expectation of a significant increase in natural gas revenue due to favorable market conditions and diversified exposure, particularly in the Delaware Basin, could drive substantial revenue growth as demand continues to rise.

Devon Energy Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Devon Energy's revenue will grow by 3.1% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 19.1% today to 16.9% in 3 years time.
• Analysts expect earnings to reach $2.8 billion (and earnings per share of $4.78) by about March 2028, down from $2.9 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $3.6 billion in earnings, and the most bearish expecting $2.1 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 15.4x on those 2028 earnings, up from 7.9x today. This future PE is greater than the current PE for the US Oil and Gas industry at 12.7x.
• 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 8.07%, as per the Simply Wall St company report.

Devon Energy Future Earnings Per Share Growth

Risks

• The dissolution of the joint venture with BPX might not yield the anticipated $2 million cost savings per well due to potential operational challenges and integration costs, which could affect net margins and profitability.
  
• While the company plans to reduce capital expenditures, the focus on the Delaware Basin with a mixed allocation of multi-zone projects could lead to operational complexities that may impact production targets and, by extension, future revenue generation.
  
• Although Devon boasts a flexible balance sheet strategy with a focus on dividends and share repurchase programs, the current allocation may limit further debt reduction, potentially affecting the financial leverage and risk profile.
  
• The company relies heavily on the Delaware Basin for over 50% of investment, and any unfavorable changes in this region's operational performance could negatively impact earnings and cash flow forecasts.
  
• Devon's strategy does not currently prioritize significant gas production increases, which could limit revenue diversification and income potential during periods of high natural gas prices.

Valuation

• The analysts have a consensus price target of $49.175 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 $42.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $16.6 billion, earnings will come to $2.8 billion, and it would be trading on a PE ratio of 15.4x, assuming you use a discount rate of 8.1%.
• Given the current share price of $35.37, the analyst price target of $49.17 is 28.1% 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.