The market’s uncertainty and volatility throughout 2023 has kept a lot of stocks hovering around new, historical lows.
Seeing stocks on the low side of their historical movements is something that makes the typical, growth-oriented investor nervous. The longer that condition lasts, and an actual bear market is maintained, the more it tends to flush most of these investors out of the market, often for several years at a time. The irony of that fact is that, the longer a bear market lasts, the more you also see the stock prices of strong, well-run corporations become compelling bargains. Another irony is that while many of the major market averages have pushed high enough to have a lot of people saying the bear is over, most of those gains have been fueled by just a few major players. In the meantime, other indices, like the Russell 2000, which represent a broad set of mid and low-cap stocks, remain firmly entrenched at bear market levels.
Uncertain economic conditions tend to shift the way investors think about sectors of the economy and the industries that define them. While broadly bearish conditions affect most sectors negatively, the flip side is that for some industries, those same conditions create more interesting long-term opportunities. One area where I think that’s true right now is in the Energy sector. There are a lot of dynamics at play at any given time that make the sector pretty volatile, and that is certainly true right now. Russia’s invasion of Ukraine is an excellent example, as the fact that major portions of global energy production transportation, and storage run through both countries in that region. That reality is just one reason that energy prices peaked in mid-2022.
Prices have moderated significantly from that peak as of this writing, which has been both a positive and a negative for the companies that make up the sector. Negative, as declining crude and natural gas prices cut into profit margins, but also positive as they help to stimulate demand. In any event, the stability of energy prices will certainly continue to impact not only the profitability of companies in the industry, but also the movement of their stock prices.
Devon Energy Corp (DVN) is an interesting company in the Oil & Gas industry. With crude prices currently sitting at around $69 per barrel, DVN’s model has historically been built to be profitable at significantly lower prices. From its own peak in November of last year at around $79, the stock has dropped nearly -40% to its current level around $47. Are the stock’s fundamentals strong enough to support the idea the stock should be higher, and is there a useful value proposition in place? Let’s find out.
Fundamental and Value Profile
Devon Energy Corporation is an independent energy company. The Company is engaged primarily in the exploration, development and production of oil, natural gas and natural gas and natural gas liquids. The Company’s oil and gas properties include the Delaware Basin, Anadarko Basin, Williston Basin, Eagle Ford, and Powder River Basin. The Delaware Basin operates approximately 16 rigs that offer exploration and development opportunities from geologic reservoirs, including the Wolfcamp, Bone Spring, Avalon, and Delaware formations. The Company’s Anadarko Basin is located primarily in Oklahoma’s Canadian, Kingfisher and Blaine counties. It operates approximately four rig programs associated with this joint venture. The Williston Basin is located on the Fort Berthold Indian Reservation in North Dakota, and its operations are focused on the oil-prone Bakken and Three Forks formations. The Eagle Ford operations are located in Texas DeWitt and Karnes counties. DVN has a current market cap of about $30.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by about -22.3%, while revenue growth was flat, but positive, at 0.29%. In the last quarter, earnings declined by -12.05% while sales slid -11.07% lower. The company operates with a margin profile that, while still robust, is also showing signs of weakness. Over the last twelve months, Net Income as a percentage of revenues was 31.39%, and narrowed to 26.03% in the last quarter.
Free Cash Flow: DVN’s free cash flow is healthy, at almost $2.8 billion over the last twelve months. This is a decline over the past year, when Free Cash Flow was $5.56 billion, as well as $3.4 billion in the quarter prior. Its current level translates to a Free Cash Flow Yield of 9.2%.
Debt/Equity: DVN carries a Debt/Equity ratio of .56. This is a generally conservative number that suggests management applies a conservative approach to leverage. Their balance sheet shows $887 million in cash and liquid assets against about $6.175 billion in long-term debt. It is worth nothing that a year ago, cash was nearly $3.5 billion.
Dividend: DVN’s annual divided is $4.51 per share, which translates to an impressive yield of about 9.57% at the stock’s current price. The company’s payout is a little under 50% of their earnings per share for the past year, and it’s worth noting that management decreased the dividend from $5.06 per share after the latest earnings report.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target a little below $51 per share. That means the stock is somewhat undervalued, with about 8% upside from the stock’s current price, and a practical discount at around $41 per share. It’s also worth pointing out that at the beginning of this year, this same metric yielded a fair value target at around $65 per share, and $57 per share prior to the most recent earnings data.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The diagonal, dotted red line traces the stock’s downward trend from its high in November of last year at around $79 to its low, reached in March at around $44. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that low, the stock has settled into a clear consolidation pattern, with immediate resistance at around $50, and current support at about $46, with the stock currently trailing back toward current support. A drop below $46 should see the stock retest its 52-week low at $44, while a push above $50 should find next resistance at around $52, with $55 possible if buying activity and momentum accelerates.
Near-term Keys: The stock’s trend is strongly bearish, with the stock’s consolidation over the last couple of months providing a stabilization that could drive the stock into a new bullish trend if broader conditions play into DVN’s favor. If you prefer working with short-term trading strategies, a push above $50 could be a signal to think about buying the stock or working with call options, using $52 as a useful, initial bullish profit target and $55 reachable if buying activity increases. A drop below $46 could be a signal to consider shorting the stock or buying put options, with the stock’s yearly low at $444 acting as a useful near-term exit target. What about value? I like DVN’s fundamentals, but do see declining Free Cash Flow and liquidity, combined with the stock’s long-term downward trend as risk elements that I think validate the reality that DVN’s value proposition isn’t good enough right now to make a useful bargain opportunity.