Devon Energy Corporation NYSE: DVN

Transcription

1 Devon Energy Corporation NYSE: DVN

2 June 27, 2013 Volume XXXIX, Issue VI Devon Energy Corporation NYSE: DVN Dow Jones Indus: 15, Initially Probed: Volume XXXVIII, Issue $56.85 S&P 500: 1, Last Probed: Volume XXXVIII, Issue XI & $52.13 Russell 2000: Trigger: No Index Component: S&P 500 Type of Situation: Business Value Price: $ Shares Outstanding (MM): 401 Fully Diluted (MM) (% Increase): 401 Average Daily Volume (MM): 3.4 Market Cap (MM): $ 20,996 Enterprise Value (MM): $ 26,647 Percentage Closely Held: ~7% 52-Week High/Low: $ 63.49/ Year High/Low: $ /39.92 Trailing Twelve Months Price/Earnings: 18.1x Price/Stated Book Value: 1.1x Net Debt (MM): $ 5,651 Upside to Estimate of Intrinsic Value: 73% Dividend: $ 0.88 Yield: 1.70% Net Revenue Per Share: LTM: $ : $ : $ : $ Earnings Per Share: 2012: $ : $ : $ 5.29 Fiscal Year Ends: Company Address: Telephone: President & CEO: December West Sheridan Road Oklahoma City, OK John Richels Clients of Boyar Asset Management, Inc. own 650 shares of Devon Energy Corporation common stock at a cost of $ per share. Analysts employed by Boyar s Intrinsic Value Research LLC own shares of DVN common stock. Overview Devon Energy Corporation ( DVN, Devon, or the Company ) is a well established firm in the Oil and Gas Exploration and Production sector ( E&P ). The firm has been in operation for over 40 years, but has made significant strategic changes during recent years. The Company elected to focus on its core operations within the North American onshore area, and divest all offshore and international assets. Moreover, it has decided to focus its future production growth on higherreturn crude oil and NGL (natural gas liquids) projects, and shift its future production focus away from natural gas. Recent results have illustrated that this transition is being effectively executed, and production growth from new projects is beginning to ramp up. The Company s strategic changes have been accompanied by several financial developments we consider to be beneficial from a shareholder perspective. Much of the proceeds generated from asset sales during recent years have been used to reduce debt and return cash to shareholders. DVN has reduced its net debt by about 20% since Additionally, the Company has repurchased 20% of its shares and increased its dividend 8 times since 2004 (current yield is 1.7%). This track record, combined with its strong balance sheet, disciplined capital spending approach, and emphasis on organic growth help to illustrate a shareholder orientation at DVN that is not always prevalent within the E&P sector

3 Despite the Company s solid financial position and strategic progress, DVN shares have failed to participate in the broader market rally during recent quarters. Over the past year, the stock has declined 7%, underperforming both the S&P 500 and its industry peers by wide margins (advances of 21% and 26% for the S&P 500 and its industry peers). Yet, DVN has announced several new developments since AAF s initial report on the Company last June that could provide potential catalysts for value creation. DVN s plan to repatriate $2 billion in overseas cash should allow the firm to reduce debt, and return additional capital to shareholders. Moreover, its plan to spin off its U.S. midstream assets into an MLP during the coming months should highlight the market value of this underappreciated aspect of the Company portfolio. Our estimate of intrinsic value for DVN is $90 per share, and assumes a relatively modest 5.0x EV/EBITDA multiple (applied to our 2015 estimate), implying total return potential of 73%. Background & Business Description Devon Energy has been in operation for over 40 years, and started from relatively modest beginnings. The firm was founded in 1971 by John Nichols and his son Larry Nichols. John Nichols had already been in the energy sector for several decades (an accountant by trade), and had established a successful track record at energy partnership Blackwood and Nichols. Larry Nichols had a background in both geology and law, and joined his father to start Devon after graduating from law school and working for both the U.S. Supreme Court and U.S. Attorney General s office. During the 1970s, the Company focused on mature natural gas projects in North America (a less popular investment opportunity within the sector at the time). The management team gradually built DVN s operations through a series of acquisitions during the ensuing years, and the firm eventually became a Master Limited Partnership in After several years of depressed energy prices and some tax law changes, DVN eventually abandoned the MLP structure and elected to become a public company in As a public firm, DVN continued to pursue several M&A transactions (largely focused in the U.S. and Canada), and had become one of the most prominent independent U.S. E&P operators by the late 1990s. A 2000 merger with Santa Fe Snyder significantly bolstered DVN s overseas presence. In addition, its 2001 acquisition of Mitchell Energy helped establish DVN s position in the Barnett Shale area. However, the firm has become less acquisitive over the past decade (a $2.2 billion acquisition of an E&P operator in the Barnett Shale called Chief Holdings in 2006 is the main exception), and it created a separate division for its marketing and midstream operations in During recent years, DVN has taken steps to sharpen its strategic focus on its core production areas (onshore projects in the U.S. and Canada) while also creating shareholder value via debt reduction, share repurchases, and a growing dividend. Management has taken several steps to implement its revised strategy. During 2004, DVN announced plans to sell $2 billion in assets, repurchase 10% of its shares, and double its dividend. In 2010, DVN divested $10 billion in assets in the Gulf of Mexico, Brazil, and Azerbaijan. During subsequent years, DVN has maintained this strategic focus, and announced several increases to both its dividend and share repurchase authorization. Today, DVN remains one of the largest independent E&P operators based in the U.S. (headquartered in Oklahoma City). Its renewed focus on North American onshore projects is readily apparent upon examining its portfolio of current and existing projects (see following map)

4 Devon Today - North American Onshore Projects Source: Company presentation, June 2013 As its map of production properties illustrates, DVN has a well established presence across much of the North American onshore production market. Much of its assets are located in geographic clusters, reflecting an investment approach that emphasizes stable production areas where DVN has already built a presence, infrastructure, and expertise. Although its footprint no longer consists of some of the more high profile areas within the E&P sector (offshore projects, overseas projects, etc.), from our perspective this portfolio offers meaningful growth and a relatively more predictable outlook for future production. We regard the North American onshore as an attractive region given its political stability relative to other energy producing regions. Moreover, by focusing on onshore projects, DVN avoids projects that can both be capital intensive and higher risk from an operational perspective. The Company has a fairly diverse geographical footprint across the North American continent, with a particular emphasis on the Southwestern U.S., U.S. Rocky Mountain region, and Western Canada. As of the most recent quarter, DVN had daily production of approximately 687,000 BOE (barrels of oil equivalent). Natural gas projects represent the largest source of current production, accounting for 59% of output. Crude oil represented 24% of output in 1Q-2013, and NGLs such as propane, butane, and ethane represented the balance of production (17%). DVN s overall proved reserves now stand at approximately 3 billion BOE, with natural gas representing 53% of reserves (down from 58% in 2012), and crude oil and NGLs representing the remaining 47% (up from 42% in 2012)

5 Devon Energy: Proved Reserves MMBoe % of Total % Natural Gas % Liquids United States Barnett Shale 1, % 76.3% 23.7% Cana-Woodford Shale % 58.6% 41.4% Permian Basin % 20.4% 79.6% Gulf Coast/East Texas % 75.0% 25.0% Rocky Mountains % 62.9% 37.1% Granite Wash % 59.0% 41.0% Mississippian 6 0.2% 38.5% 61.5% Other % 67.4% 32.6% Total United States 2, % 65.3% 34.7% Canada Canadian Oil Sands % 0.0% 100.0% Lloydminster % 13.1% 86.9% Other % 67.6% 32.4% Total Canada % 15.7% 84.3% Total Devon 2, % 53.1% 46.9% Despite lacking a presence in some of the more well-known and emerging energy areas, DVN has achieved an impressive production record from a historical perspective. During the period DVN achieved a production CAGR of 7% and average annual reserve replacement (proved reserves added relative to production) of over 200% within the North American onshore region. Importantly, this record was achieved during a period in which DVN pursued little in the way of M&A opportunities (with the exception of the $2.2 billion acquisition of Chief Holdings in 2006). However, production growth trends have been less robust during recent quarters. For 2012, DVN achieved overall production growth of just 4%, as liquids growth more than offset declining natural gas output. During the most recent quarter, production actually declined about 1% on a year-over-year basis as solid growth in crude oil failed to offset a substantial decline in natural gas production. In our view, the firm s shift in production emphasis from natural gas to liquids explains much of this near-term shortfall and quarterly volatility. Although increasing production is a key aspect of the firm s future growth profile, we would caution against placing undue emphasis on quarterly fluctuations. Importantly, DVN is not just an E&P company, it also owns natural gas pipelines and treatment facilities (marketing and midstream operations), and is one of North America s largest processors of natural gas, owning about 16,000 miles of pipeline. Although DVN s marketing and midstream operations are a more modest contributor to its financial results, this segment possesses a meaningful strategic role within DVN. This business helps DVN to bring much of its daily natural gas and NGLs to market, and enables DVN to buy and sell commodities from third parties. Moreover, having access to these assets significantly enhances DVN s overall operating efficiency. According to Company estimates, the firm s midstream operations increase DVN s overall margins by about $2 per BOE. During the most recent fiscal year, DVN generated about $9.5 billion in revenue (see following chart), derived from its upstream operations (76%), marketing and midstream (17%), and gains from oil, gas, and NGL derivatives (7%)

6 2012 Revenue 1Q-2013 Production Marketing & Midstream Oil, Gas & 18% Derivatives 7% Oil, Gas & NGL Sales 75% Crude Oil 24% NGLs 17% Natural Gas 59% 2012 Revenue: $9.5 billion 1Q 2013 Production: 687 MBOE/day Management Larry Nichols (DVN s co-founder) is still Executive Chairman of the firm, but he is the only member of the founding family still present on the management team. The Company s management team consists of seasoned executives, with significant experience in the energy sector. Insiders own about 7% of the Company. DVN encourages stock ownership by its employees, and senior executives have stock ownership requirements (as a multiple of base salary).the following table provides some additional background on DVN s executive team. Executive Age Background Larry Nichols-Executive Chairman 70 Co-founder of Devon, CEO of Devon John Richels-President & CEO 62 Several executive positions at Devon since 1998 David Hager-COO 56 Joined Devon in 2009, previously at Kerr McGee Jeff Agosta-Executive V.P. & CFO 46 Promoted to CFO in 2010 after 13 years with Devon Tony Vaughn-Executive V.P. of Exploration & Production 55 Executive at Kerr-McGee before joining Devon in 1999 Darryl Smette-Executive V.P. of Marketing & Midstream 66 Appointed to position in 1999, joined Devon in 1986 Recent Developments at Devon Energy Devon Reports 1Q-2013 Earnings, Production Exceeds Company Guidance DVN reported adjusted EPS of $0.66 for 1Q-2013 (excluding non-cash impairment charges). Adjusted EPS declined 37% on a year-over-year basis, but exceeded expectations by $0.10. Weak commodity pricing continued to weigh on Company profits, as average realized price per BOE declined 7% year-over-year. Production was down modestly compared to 1Q-2012, but exceeded the top end of management s previous guidance. Production comparisons benefited from better than expected oil production, reflecting operational progress with several projects as the firm continues to transition its production away from natural gas. Crude oil and NGLs accounted for 41% of total Company production during the period, up from 37% in 1Q DVN s oil production in the Permian Basin (primarily located in Texas) was particularly strong, up 24%. The Company also reported encouraging growth in other U.S. projects such as Mississippian (Oklahoma), and several projects in the Rocky Mountain region. Management expects this ramp-up in domestic oil production to continue, and believes that 40% growth in U.S. oil production could be attainable in Oil production growth in DVN s Jackfish projects (Alberta) was also robust, increasing 18% during the period. Results from the firm s midstream operations also exceeded expectations, reflected by a 12% year-over-year increase in operating profit. Total production costs during the period were $14.54 per BOE, down about 4%. Midstream margins were aided by higher natural gas prices and effective cost control efforts. DVN believes the midstream business is on track to achieve operating income of $425 million-$475 million for the full year

7 DVN indicated that it plans to repatriate approximately $2 billion in overseas cash by the end of this year, and a comparable repatriation may be feasible in 2014 as well. (DVN has about $6 billion in overseas cash due to past asset sales.) Due to NOLs and other tax benefits accumulated by the Company, DVN believes it can achieve this repatriation at a low-mid single-digit tax rate. Moreover, management indicated that it was actively exploring ways to monetize part of its U.S. midstream operations as a means of creating shareholder value (via a spinoff). Devon Announces Plan to Spin Off U.S. Midstream Assets In June of this year, management announced its plan to spin off a portion of DVN s midstream assets. The midstream assets will be spun off as an MLP, and DVN will continue to hold a majority interest in these operations. These assets largely consist of natural gas gathering and processing assets located in Texas, Oklahoma, and Wyoming, and include 6,500 miles of pipelines, 300 compressor units, and 8 natural gas processing plants. A registration for this spinoff is scheduled to be filed during 3Q-2013, with the corresponding spinoff to occur during the following months. The objective of the spinoff is to create shareholder value by allowing the market to establish a stand-alone value for DVN s midstream business. Moreover, this new MLP is likely to offer a higher dividend yield to shareholders relative to DVN stock. DVN had periodically considered a spinoff of these midstream assets in the past, but believes that current market conditions and increased prevalence of Energy MLPs now offer a more favorable environment for such a transaction. Based on very preliminary estimates, DVN s total midstream assets (U.S. and Canada) could have an intrinsic value of approximately $3 billion (roughly 15% of DVN s current market capitalization). However, a more accurate estimation will be attainable as DVN discloses more about the midstream business and the upcoming spinoff later this year. Natural Gas in North America: Reasons for Long-Term Optimism Although DVN is transitioning its production emphasis to liquids, natural gas production will continue to be a very significant aspect of its operations for the foreseeable future. Many significant changes have occurred within the North American natural gas market over the past decade. The dominant issue facing the industry during recent years has been the increased supply of natural gas resulting from advancement in technology (hydraulic fracturing) and the development of shale gas. These drivers of new production have caused a supply/demand imbalance, which has ultimately caused a correction in natural gas prices. Although natural gas pricing has shown some signs of strength during recent quarters (prices up about 15% year to date), prices are still fairly depressed from a historical perspective (see following chart). Attempting to forecast near-term price fluctuations in natural gas or other commodities can often prove to be futile. However, we believe there are several reasons to believe that natural gas prices should be positioned for a recovery in North America during the coming years. Specifically, sources of new demand growth such as power generation, LNG (Liquefied Natural Gas) exports, and the transportation industry should help to absorb the substantial new supplies that have impacted pricing during recent years. Henry Hub Gulf Coast Natural Gas Spot Price Source: U.S. Energy Information Administration - 6 -

8 Use of natural gas as a fuel for power generation has become increasingly prevalent within the utility industry. The environmental profile of natural gas is significantly more attractive relative to other traditional fuel sources. Natural gas is considered to be the cleanest burning fossil fuel, emitting 30% less carbon dioxide than crude oil and 45% less carbon dioxide than coal. Coal remains a cheaper fuel source for most power producers despite the decline in natural gas prices during recent years, but new environmental standards in the United States will likely narrow this gap during the coming years. Currently, coal remains the largest fuel source in the United States, but the mix is gradually shifting to natural gas over time. According to the U.S. Energy Information Agency, coal declined from 51% of fuel to 42% of fuel for utilities during the period alone, and this figure is projected to drop to 35% by During 2012, natural gas powered generation represented the largest source of new capacity (37%), more than double the coal powered generation added during the same period. The worldwide LNG market has grown substantially during recent decades, and represents a substantial long-term solution to supply/demand imbalances and pricing discrepancies across global markets. The technology associated with LNG allows natural gas to be converted to liquid form for ship transport, and is later converted back to gas upon arrival to its destination market. However, establishment of the necessary infrastructure is a very capital intensive process, often requiring a multi-billion dollar investment, but costs associated with LNG projects have been gradually declining over the years, reflecting technological advancements. Currently there are 18 countries equipped to export LNG and 25 countries equipped to import LNG, and overall global trade has quintupled since the early 1990s. Importantly, there is substantial capacity being added to the North American market, which should enable export of excess supplies to higher-priced natural gas markets such as Japan and Europe. According to Devon, there is approximately 20 BCF/day in LNG export capacity being added in the United States within the next 5-10 years (total current U.S. natural gas production stands at 70 BCF/day), up from no LNG currently exported from the U.S. market. Natural gas has also become an increasingly important alternative fuel source for many aspects of the transportation industry in North America. The use of alternative fuels has been growing at a low-teens rate during recent years, and natural gas is the most prevalent fuel within this category (representing nearly half of all alternative fuels used for U.S. transportation). Its competitive cost and attractive environmental profile have been among the catalysts for this growth. This growth is expected to continue for the foreseeable future. According to a report by the International Energy Agency, natural gas is expected to cover 10% of new fuel demand in the transportation industry going forward. Due to considerations related to station infrastructure, fuel cost economics, and proximity to fueling stations, natural gas has been gaining particular traction within the trucking sector. According to a report by the New York Times, the average cost of natural gas can be $1.50 per gallon cheaper than diesel fuel, offering significant savings to trucking operators. In our view, it is inevitable that natural gas will continue to gain prominence as a fuel source in North America. This consideration, combined with the other previously discussed demand drivers suggest that supply/demand dynamics for North American natural gas should be positioned for continued improvement over the long-term. The Evolving Production Outlook for Devon Energy Strategy Going forward we expect DVN to maintain its strategy of pursuing attractive growth opportunities within its core regions, while maintaining its strong financial profile. As management has frequently stated, these growth opportunities should largely consist of organic expansion of new and existing projects, with many projects occurring in areas where DVN already has a long operating history. Moreover, new production will emphasize higher return projects that produce crude oil and NGLs. Roughly 59% of current output consists of natural gas, down from 63% just 1 year ago. This transition has been aided by significant growth in crude oil production, which has more than doubled within DVN s core operating area since 2007 (see following chart). This trend should continue for the foreseeable future; DVN expects natural gas projects to represent less than half of total production by Importantly, new growth has been funded while maintaining relatively low financial leverage. In our view, DVN s strategy strikes an appropriate balance between financial strength and future growth. Although investors may be more focused on near-term commodity price challenges, the benefits of DVN s strategy should become more apparent during the coming years, reflected in a growing and more profitable production profile

9 Oil Production Growth Production Data in MBOPD Source: Company presentation, June 2013 Updates on Key Projects Although DVN has exited from some of the more high-profile and emerging production areas, it continues to possess a portfolio that contains many attractive growth opportunities. Some investors may consider North American onshore production to be relatively mature with only modest growth potential during future years. However, we would regard such a view as misguided, and believe DVN s existing and future projects offer very meaningful production upside over the long-term. DVN management announced a goal of achieving a production CAGR of 6%-8% during the period. Recent results suggest that reaching that goal may be a challenge. However, we would expect production growth to begin to accelerate in the future. DVN s future production growth will be derived from a combination of new and existing projects. Projects such as the Barnett Shale (North Texas), Cana Woodford Shale (Oklahoma), the Permian Basin (Texas/New Mexico), and the Canadian Oil Sands (Western Canada) should remain the most important projects within DVN s E&P portfolio. The following offers a more detailed description and analysis of DVN s most significant production areas: Barnett Shale: The Barnett Shale, located in North Texas, is by far DVN s most significant project, representing 36% of proved reserves and 33% of production. The Barnett Shale produces natural gas and NGLs, and is one of the largest gas fields in North America. DVN has been an operator there for over a decade, and the Company is the largest operator in the area. Liquids will likely represent the main source of new output going forward (21% of current production), but the recent uptick in natural gas prices will make Barnett a key source of cash flow. Management expects Barnett to generate $600 million in free cash flow for DVN in 2013 alone. Cana-Woodford Shale: The Cana-Woodford Shale is located in Western Oklahoma, and accounts for about 14% of DVN s total proved reserves, and about 7% of the firm s daily output. The project largely yields natural gas and NGLs, and has emerged as a high growth project for DVN (DVN s production from Cana-Woodford increased 45% in 2012). During the most recent quarter, total production was up 26%, and liquids production posted a 78% increase. DVN is the largest producer and leaseholder in the area and it has plans to further expand its drilling operations there. Permian Basin: Although the Permian is a relatively mature and well-established project, it also offers meaningful production growth potential for DVN. This area is a key source of new crude oil output for the Company. Oil production during the most recent quarter achieved a 24% year-overyear increase, and management believes a 40% increase should be attainable for 2013 as - 8 -

10 several wells continue to ramp up. DVN is among the most prominent operators in the Permian, with approximately 1.3 million net acres. The Permian represents 8% of DVN s total reserves and 9% of its current production. Canadian Oil Sands: DVN is the only U.S. based independent E&P to develop and operate a project in the Canadian Oil Sands. During 2012, it represented DVN s second largest source of proved reserves (18% of DVN s total portfolio), and accounted for approximately 7% of DVN s total production. During the most recent quarter, total production from this area dropped by about 5%, as reduced natural gas output more than offset growth in liquids. DVN s heavy oil projects in Western Canada will likely remain one of the Company s key sources of new oil production. DVN s projects in this region (Jackfish 1, Jackfish 2, Jackfish 3, and others) are considered to be low risk projects from a geological perspective, and reserve life is estimated to exceed 25 years. In our view, DVN has an attractive set of production growth opportunities that should enable its continued transition from natural gas to liquids. The Company s target of deriving over 50% of production from liquids by 2016 should be attainable from our perspective. We believe DVN is positioning itself to achieve significant growth in profits and cash flows during the coming years, assuming commodity prices are at relatively normalized levels (our estimates assume an $80 price for crude oil and a $4 per mcf price for natural gas). By our estimates, DVN should be capable of generating at least $8.00 in annual EPS and $8 billion in annual EBITDA during the next 2-3 years, more than double general expectations for the current year. Importantly, our estimates assume relatively modest rates of production growth during the coming years (3%-5% per year). Balance Sheet and Financial Position In our view, maintaining a strong financial position and disciplined capital allocation through all phases of the industry cycle is a particularly important issue within the E&P sector. In the past, many E&P companies have tended to take on additional financial leverage when energy prices are robust, assuming the strong pricing environment will remain intact over the long-term. Inevitably, energy prices prove much less predictable, and are often subject to significant and extended corrections. As a result, both M&A and capital investments that were once justified by a buoyant industry environment can become much less attractive, often translating to deteriorating returns on capital and financial distress. We believe firms that exhibit a more conservative investment approach and a strong balance sheet hold a superior competitive position within the sector, allowing such companies to better endure industry downturns, capitalize on the attractive investment opportunities, and consistently return capital to shareholders. We believe DVN possesses many of the favorable financial characteristics just outlined. The firm s balance sheet is solid, and it holds a relatively low level of financial leverage. As of the most recent quarter, DVN had about $5.6 billion in net debt, translating to a net debt to capital ratio of 22% (cash and short term investments total approximately $6.5 billion). The Company s strategic positioning and corresponding asset sales (about $10 billion in sales in 2010) have allowed management to reduce its net debt by 20% since Moreover, management has indicated that some proceeds from the planned $2 billion overseas cash repatriation may be allocated to debt reduction. DVN s strong financial position is further illustrated by its bond ratings; the Company s ratings at Moody s and S&P are Baa1 and BBB+, respectively. DVN considers maintenance of an investment grade bond rating to be an important strategic priority. Given the firm s strong balance sheet, some investors may speculate that some type of M&A activity could become increasingly likely. We believe an expensive or transformative acquisition is a less likely scenario for DVN given the firm s conservative financial philosophy, and the Company has reiterated its preference for organic growth opportunities in recent meetings with investors. DVN s sturdy financial footing has allowed it to consistently return capital to shareholders over the years regardless of the industry environment or commodity prices. Since 2004, the Company has increased its dividend 8 times and repurchased about 20% of its share base. DVN completed a $2.5 billion share repurchase program in 4Q There is no additional authorization currently in place, but we would expect additional buyback activity to be under close consideration as the firm s cash position builds from its operations and various other sources (cash repatriation etc.). During 1Q-2013 DVN announced a 10% increase to its dividend. The current annual dividend of $0.88 per share translates to a 1.7% dividend yield, and represents a dividend payout ratio of roughly 24% (based on EPS expectations for the current year)

11 Another benefit of DVN s financial discipline is the Company s ability to fund ongoing projects regardless of the industry environment. During recent years, annual capital expenditures have been in the $6.5 billion to $8.5 billion range, but spending levels will likely be toward the lower end of this range during the next 1-2 years. Annual cash from operations has been in the $5 billion-$6 billion range, and management typically hedges about 50% of its production in order to provide some visibility and stability to future cash flows. The majority of Company investment is allocated to the development of crude oil and NGL production projects. Periodically, DVN pursues joint alliances with other energy firms to develop new prospects in order to manage its capital commitments and the overall risk of its E&P portfolio. Just during 2012, DVN announced two such transactions with Sinopec and Sumitomo. Each transaction involved an upfront sum paid to DVN, and a drill carry provision (requiring the other party to fund a portion of ongoing developments costs) in exchange for an interest in some of DVN s production projects. DVN continues to be the operator of the projects, and has ultimate responsibility for capital allocation decisions. It is conceivable that DVN could consider similar arrangements as part of its investment strategy during the coming years. Valuation & Conclusion Despite several positive developments, DVN shares remain out of favor. Since issuing our initial report on DVN in 2012, natural gas prices have shown signs of recovery (up about 15% year to date), and the Company has made positive announcements regarding cash repatriation and the MLP spinoff. Assuming commodity prices are within a normalized range during the coming years, DVN should be poised to report substantial improvements in cash flow and profitability. Moreover, its continued growth in liquids production should be a positive driver of results, and the Company s evolving production profile should become increasingly apparent to investors. Looking ahead, we expect DVN will continue to possess a solid financial and competitive position, and that recent developments provide additional potential catalysts for stock appreciation during the coming years. Given management s past emphasis on returning cash to shareholders, additional dividend increases and share repurchase activity could also be future catalysts for multiple expansion and enhanced shareholder value. As the following chart indicates, DVN is currently trading at an EV/EBITDA multiple of 6.0x (from a trailing twelve month perspective), representing almost a 15% discount to its peer group. Part of this discount has been created by DVN s poor historical stock performance on both an absolute and relative basis. DVN shares have declined 7% over the past year, and shares have dropped about 55% over the past 5 years, underperforming its peer group by about 30 percentage points over both time periods. In our view, this performance gap helps to illustrate how poor investor sentiment has become for DVN shares, and the increasingly favorable risk/reward scenario that is being created. Based on our assumptions for 2015, which reflect DVN s evolving production profile and a normalized commodity price environment, the firm should be capable of generating annual EBITDA of at least $8 billion (total market capitalization now stands at $21 billion). This level of EBITDA implies DVN is trading at a multiple of approximately 3.2x based on an EV/EBITDA methodology. In our view, this valuation fails to reflect the Company s strategic progress in recent years, and gives little credit for potential growth in production or profits in the future. Company Name Ticker TTM EV/EBITDA 1-year price % 5-year price % Apache APA 3.9x (1.1%) (36.9%) Anadarko Petroleum APC 7.0x 38.5% 21.9% Chesapeake Energy CHK 5.8x 14.8% (69.2%) Denbury Resources DNR 6.3x 22.4% (47.9%) Encana ECA 11.7x (11.8%) (80.9%) EOG Resources EOG 8.7x 52.8% 8.5% Marathon Oil MRO 3.2x 44.0% (31.4%) Noble Energy NBL 9.1x 50.9% 30.6% Average 7.0x 26.3% (25.7%) Devon Energy DVN 6.0x (6.8%) (55.6%)

12

13

14 Analyst Certification Asset Analysis Focus certifies that the views expressed in this report accurately reflect the personal views of our analysts about the subject securities and issuers mentioned. We also certify that no part of our analysts compensation was, is, or will be, directly or indirectly, related to the specific views expressed in this report. Asset Analysis Focus is not an investment advisory bulletin, recommending the purchase or sale of any security. Rather it should be used as a guide in aiding the investment community to better understand the intrinsic worth of a corporation. The service is not intended to replace fundamental research, but should be used in conjunction with it. Additional information is available on request. The statistical and other information contained in this document has been obtained from official reports, current manuals and other sources which we believe reliable. While we cannot guarantee its entire accuracy or completeness, we believe it may be accepted as substantially correct. Boyar s Intrinsic Value Research LLC, its officers, directors and employees may at times have a position in any security mentioned herein. Boyar s Intrinsic Value Research LLC Copyright