Devon Energy (IL/A): Downgraded to IL from OP on relative valuation
Goldman Sachs May 26, 2005
We have lowered our rating on Devon Energy's shares to In-Line from Outperform (in the context of an Attractive coverage) on the basis of relative valuation, as we now see greater relative upside in the shares of Occidental Petroleum, which we have upgraded to OP from IL. There is no change to our favorable view of DVN's outlook and strategic direction and we continue to consider it one of our favorite large-cap E&P equities. EnCana (OP/A) remains our top large-cap E&P pick. Between Apache, EOG Resources, and Devon (all IL/A), we see APA as the least expensive at this time and now consider it our second favorite large-cap E&P after ECA. We believe DVN's attractive core onshore North America asset base, deepwater Gulf of Mexico and West Africa exploration upside, and its commitment to returning excess cash to investors bode well for its shareholders. Please see our separate report on Occidental Petroleum published today for additional details on our favorable view of it. We have made no changes to our earnings estimates or expected valuation trading ranges for Devon's shares at this time.
OXY'S RELATIVE RISK/REWARD LOOKS MORE FAVORABLE TO US THAN DEVON'S AT THIS TIME
We believe Devon Energy's shares can continue to perform well on an absolute basis, given our bullish energy commodity macro outlook and Attractive coverage view. On a relative basis, however, we see Devon's relative valuation as less compelling at this time. Given our improved view of Occidental Petroleum's outlook and risk/reward, we see greater relative and absolute upside in Oxy's share and have upgraded it to Outperform from In-Line replacing Devon among our portfolio of top picks.
WE CONTINUE TO HAVE A FAVORABLE VIEW OF DEVON'S STRATEGY AND OUTLOOK
Investors should not read into our relative valuation-based downgrade of Devon's shares any disappointment or concerns with the company's strategy or outlook. We believe the company has amassed an attractive asset base of onshore North America natural gas development opportunities balanced with a high-risk/high-potential deepwater exploration program in the Gulf of Mexico and West Africa. We also like the company's emerging exposure to Canadian oil sands via its Jackfish project. Finally, we view favorably Devon's increasing commitment to return excess cash to shareholders via stock buyback and common dividends. In the near-term, we believe key company-specific catalysts (i.e., beyond commodity price movements that impact just about all the companies we cover) for Devon include the ramp-up in its non-core Barnett Shale drilling program and its exposure to high-risk/high-potential wells in the Gulf of Mexico and West Africa that are either currently drilling or will spud later this year. We believe Devon is on-track to organically replace over 100% of its E&P production at F&D costs below $10/BOE in 2005 and likely over the next several years.
DVN'S RELATIVE VALUATION IS LESS COMPELLING: ECA TOP LARGE-CAP E&P PICK NOW FOLLOWED BY APA
We now believe Devon's current relative valuation better reflects its favorable outlook. Devon is trading at 4.6X 2006E and 6.4X 2007N EV/DACF, which is in-line with the large-cap E&P average of 4.6X 2006E and 6.6X 2007N EV/DACF. Owing to the even more favorable view we have of its North America unconventional gas-focused asset base, EnCana (OP/A) remains our favorite large-cap E&P. Although we think it is a close call between Devon, Apache, and EOG Resources (all IL/A), we now consider Apache our second favorite large-cap E&P owing to the fact that its shares have trailed the sector in 2005 and appear very inexpensive. On our estimates, Apache is trading at just 3.8X 2006E and 6.1X 2007N EV/DACF, well below the peer group average for what has otherwise been one of the top performing E&P companies over long periods of time.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
