Are DVN’s fundamentals strong enough to support a long-term trend reversal?

Over the last week, the market has pulled back just a bit; after reaching yet another, fresh all-time high following the formal signing of Phase One of a trade agreement between the U.S. and China, the S&P 500 has dropped not quite -1%. Last week’s bearish momentum was strong enough that I noticed a few talking heads on popular market media talking about the risk the market could finally be reaching a peak. That uncertainty, combined with geopolitical risks in the Middle East – related to U.S. sanctions on Iran – have kept energy prices under pressure. As a result, the entire Energy sector has struggled for the past month, dropping almost -9 over that time period, with approximately half of that decline (-4.84%) coming in the last week.

While I think the market has been riding along the edge of that risk for a couple of years now, I’m not entirely sure it’s quite time yet. Interest rates remain extremely low, with Fed statements continuing to strike an accommodative tone. I think that as broad economic indicators go, interest rates have proven to be the most reliable way to identify important sea changes in economic health. Rates will have to start going up again – probably at a steeper rate than the last set of gradual increases the Fed followed until early last year – before I believe the economy is likely to reverse its current course of gradual, “Goldilocks”-style growth.

That means that while the market’s current drop might not be long-lasting, it could simply fit into the category of “healthy drawdown” – the kind of short-term pullbacks that have offered so many opportunities over the last ten years to “buy the dip” and ride a fresh wave of bullish momentum higher. If that is the case, the Energy sector’s drop could offer an excellent to buy a number of stocks in the sector at significant discounts.

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 $53, and forecasted to be above $60 in 2020 by both industry analysts and corporate managers alike, DVN’s model looks conservative. Since November, the stock has rebounded from a long-term trend low price at around $20 to form a short-term upward trend that peaked in late December at around $26, and then began to hover around that price until about a week ago. The stock has dropped back nearly -10% from that peak in the last week, and that could be offering the kind of attractive “buy the dip” opportunity I referred to earlier. Are the stock’s fundamentals strong enough to support the idea the stock should be higher, and it there enough of value proposition in place? Let’s find out.

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 $9.2 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 14.7%, but declined to 5.9% 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 6.39%.

Dividend: DVN’s annual divided is $.36 per share, which translates to a yield of about 1.5% at the stock’s current price. It is also worth noting that the dividend increased from $.32 per share earlier this year.

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 1.4 at the stock’s current price. The stock’s historical average Price/Book ratio is 2.49, meaning that the stock is almost 78% below its historical Price/Book ratio. That offers a long-term target price above $42 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 April of last year 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 to about $26, a bit above the 38.2% retracement line by the end of December, but has dropped back from that point in the last week. Immediate support appears to be around $23, with resistance at the 38.2% retracement line. A push below support could see the stock test its next support anywhere between $20 and $21. A bounce off of support at $23 should give the stock momentum to rally to about $26 per share in the short-term.

Near-term Keys: The stock’s momentum right now is strongly bearish, but the stock does appear to be reaching an important signal point. A bounce off support at $23 could offer an interesting short-term opportunity with call options or buying the stock outright with a quick-exit target at around $26 per share, while a push below that level could signal a useful opportunity to short the stock or to buy put options with an eye on $20 to $21 as a target price. 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 shift from intriguing to compelling.

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