Delaware Basin And Grayson Mill Drive Record Oil Production And Revenue Surge

Key Takeaways

• Devon Energy's record oil production in the Delaware Basin and effective cost management are key drivers of revenue and net margin improvements.
  
• Strategic acquisitions, like Grayson Mill, and an expanded share repurchase program highlight a focus on increasing earnings and enhancing shareholder value.
  
• Devon Energy's strategy focusing on operational efficiencies, major acquisitions, share repurchases, and pipeline investments presents risks to production, liquidity, and earnings.

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's Delaware Basin operations have led to record oil production, implicating a direct positive impact on revenue. Operational efficiencies and the addition of a temporary fourth frac crew have enhanced well productivity, which should continue to boost revenue.
  
• The company's effective cost management strategy, particularly in capital and operating expenses, is likely to improve net margins through efficient supply chain management and shorter drilling and completion cycles.
  
• Raising the 2024 production guidance for a second time, driven by legacy asset performance and bolstered by the Grayson Mill acquisition, indicates a potential increase in revenue and earnings due to higher expected production volumes.
  
• The Grayson Mill acquisition not only nearly triples Devon's production in the Williston Basin but also expands its project inventory significantly. This strategic move is poised to enhance earnings and free cash flow, particularly noting the transaction's expected accretion to earnings and its contribution to dividends from 2025 onward.
  
• Expanded share repurchase program by 67% to $5 billion signals a strong commitment to enhancing shareholder value and demonstrates confidence in generating substantial free cash flow. This is expected to positively influence earnings per share (EPS) by reducing the number of shares outstanding.

Assumptions

• Analysts are assuming Devon Energy's revenue will grow by 11.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 23.4% today to 17.1% in 3 years time.
• Analysts expect earnings to reach $3.6 billion (and earnings per share of $5.74) by about August 2027, up from $3.5 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $5.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.9x on those 2027 earnings, up from 7.7x today. This future PE is greater than the current PE for the US Oil and Gas industry at 10.0x.
• Analysts expect the number of shares outstanding to decline by 2.05% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.45%, as per the Simply Wall St company report.

Risks

• The reliance on operational improvements and drilling efficiencies to drive performance could pose a risk if such efficiencies plateau or regress, affecting the company's ability to maintain or increase its production and revenue.
  
• The execution of major acquisitions, like the Grayson Mill acquisition, introduces integration risks which could impact net margins if synergies or operational efficiencies fall short of expectations.
  
• The company's focus on share repurchases as a primary method of returning value to shareholders could limit liquidity for unexpected capital needs, potentially impacting its net margins.
  
• Geographic concentration in U.S. shale, particularly the Delaware and Williston basins, exposes the company to regional operational risks and market dynamics that could affect revenue and earnings if regional discounts widen or infrastructure constraints arise.
  
• The significant investment in long-term pipeline commitments, such as the commitment to the Matterhorn and Blackcomb pipelines, could pressure cash flows if production targets are not met or if market conditions change, impacting earnings negatively.

Valuation

• The analysts have a consensus price target of $58.21 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 $68.0, and the most bearish reporting a price target of just $43.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $20.9 billion, earnings will come to $3.6 billion, and it would be trading on a PE ratio of 11.9x, assuming you use a discount rate of 7.4%.
  
• Given the current share price of $43.17, the analyst's price target of $58.21 is 25.8% 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.