As the economy pushes into the thick of the holiday season, the market seems keen on finding every opportunity to remain bullish right now. Whether those clues come from trade, interest rate policy, or corporate earnings forecasts seem far less important right now than whether investors are able to find a happy rack to hang their hats on. That’s been a positive for stocks in general, including a lot of the stocks that I’ve focused on in the last few months for my value-oriented opportunities. The longer it goes on, however, the harder it gets to keep finding good value to work with.
One of the sectors that hasn’t followed broad market higher this year is the Energy sector; in fact, as measured by the S&P 500 Energy Sector SPDR (XLE), the sector is down a little over -12% over the past year and up only slightly since the beginning of 2019. Trade and a strong dollar have both weighed on the sector, including geopolitical questions in the Middle East (particularly related to Iran) and higher-than-expected inventories across the globe. All of these together have combined to hold oil prices down well below the levels most analysts forecast they would reach this year.
The contrarian, value-oriented side of me is interested in this kind of pattern; the fact the entire sector is lower, with price pressures generally expected to shift in 2020 means that if you’re careful you can find good opportunities to work with strong companies at much lower than normal prices. Devon Energy Corp (DVN) is an interesting company in the Oil & Gas industry that I think might fit that description. In its latest earnings report, DVN’s CEO addressed the broad pressures on oil prices specifically, explaining that the company’s operating model for the year ahead is built around a break-even price on WTI crude oil at around $48 per barrel. With prices currently running around $58, and forecasted to be above $60 in 2020 by both industry analysts and corporate managers alike, DVN’s model looks conservative. The stock is only a little above a multi-year low below $20 per share right now, and has been following a downward trend that began in July of 2018. Its recent rebound, however offers an interesting potential for a major trend reversal, which means that the value opportunity available could be compelling. Let’s take a look.
Fundamental and Value Profile
Devon Energy Corporation is an independent energy company. The Company’s segments include U.S. and Canada. The Company is engaged primarily in the exploration, development and production of oil, natural gas and natural gas liquids (NGLs). The Company’s operations are concentrated in various North American onshore areas in the United States and Canada. The Company’s U.S. and Canada segments are primarily engaged in oil and gas exploration and production activities. The Company’s properties include Barnett Shale, Delaware Basin, Eagle Ford, Heavy Oil, Rockies Oil and STACK. As of December 31, 2016, the Company had three operated rigs. As of December 31, 2016, the Company had approximately 66,000 net acres located in DeWitt and Lavaca counties in south Texas. As of December 31, 2016, the Company’s acreage in the Rockies included approximately 470,000 net surface acres, focused on oil opportunities in the Powder River Basin and the Wind River Basin. DVN has a current market cap of about $8.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings dropped by nearly -59%, while revenue decreased about -28%. In the last quarter, earnings declined by -39.5% while sales slid almost -4% lower. The company operates with a generally healthy margin profile that is nonetheless showing near-term signs of deterioration. Over the last twelve months, Net Income as a percentage of revenues were 15.9%, but declined to 5.84% over the last quarter.
Free Cash Flow: DVN’s free cash flow is a sign of strength, at $588 million over the last twelve months. This is an improvement from earlier this year when Free Cash Flow was a marginal $237 million in February. Its current level translates to a Free Cash Flow Yield of 6.97%.
Dividend: DVN’s annual divided is $.36 per share, which translates to a yield of about 1.58% at the stock’s current price. It is also worth noting that the dividend increased from $.32 per share two quarters ago.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for DVN is $17.03 and translates to a Price/Book ratio of 1.33 at the stock’s current price. The stock’s historical average Price/Book ratio is 2.11, meaning that the stock is more than 58% below its historical Price/Book ratio. The stock is also trading about 24% below its historical Price/Cash Flow ratio, which offers a more conservative, but still useful target at around $28 per share.
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 July of 2018 to its bottom at the end of October. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. DVN has rallied about 14.5% higher from that low point, but is a little below immediate resistance around $24. A break above that price could see the stock push to about $28, at a pivot high established in September of this year. Current support is a little below the stock’s current price, at a pivot low around $21 per share. A drop below that point should see the stock test its multiyear low at around $20, with further support at around $18 – a low the stock hasn’t seen since the first quarter of 2016.
Near-term Keys: Despite the stock’s long-term downward trend, I don’t think the probabilities favor a bearish trade right now; however if you want to be aggressive on the bearish side, a drop below $21 could offer an opportunity to short the stock or to work with put options, with an eye on $18 as a price target. A better short-term signal is on the bullish side, with a break above $24 acting as a good opportunity to buy the stock or to work with call options with an eye on the $28 pivot high from September. What about value? I like all of DVN’s fundamentals, with the exception of the sharply lower Net Income in the last quarter. My preference would be to see a material improvement in this measurement in the stock’s next earnings report. If that happens, the stock’s value proposition would very likely shift from intriguing to compelling.