Devon Energy Corp (DVN)
Ideas Engine Series; Wild Thought: There Is a Concho Resources (CXO) Lurking Within DVN;
Revising Ests & Raising TP to $90 (from $80)
10 June 2014 sendspace.com
Our take: In the early innings of the shale era, the bulk of the alpha has been generated by pure play E&Ps with franchise assets. Given wide valuation disparities between pure plays and diversified E&Ps, we believe the next thematic trade could be larger caps with underappreciated assets, such as DVN's Delaware position in the Permian Basin.
Delaware Basin growth engine. We see a Concho Resources (CXO) lurking within Devon, but we think the market does not. CXO has been one of the industry leaders in value creation and sports an EV of $18 billion. DVN has a similar acreage footprint to CXO and one of the surprises in our analysis was the fact that DVN has grown its Permian Basin production at a faster clip since 2010 and exhibited slighter better capital efficiency. DVN's horizontal well performance has lagged CXO, but DVN has remapped its geological understanding of the play and recent performance has improved markedly. Given improving drilling returns, we believe DVN could increase its horizontal rigcount to 20 from 12 in the Delaware, which underpins our above consensus production and EBITDA forecasts in 2015 and 2016.
Operational tipping point for stock: DVN has outperformed by 9% in '14, but this upside has been largely driven by successful 'self-help', including accretion from the company's midstream merger (EnLink). We believe there is powerful 'rate of change' momentum not only in the Permian, but also in the Cana-Woodford play, where returns are poised to move higher from a new completion design. We believe we are at an operational tipping point for the stock, with improving results in the Permian and Cana, plus significant FCF from its Eagle Ford, Jackfish, and Barnett Shale assets.
Raise target price: We believe market appreciation of Delaware Basin growth, a positive 'rate of change' in the Cana, and looming FCF profile are poised to drive a re-rating in DVN shares. We are raising our 12-month target price to $90 from $80, which is at parity with our revised NAV. Reiterate Outperform. We are revising our 2014-2016 EPS estimates to $5.44/$5.67/$6.40 from $5.56/$5.20/$5.62 respectively. |
