The market’s rough start to 2023 has kept a lot of stocks plumbing new, historical lows.
See 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.
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 $71 per barrel, DVN’s model has historically been built to be profitable at significantly lower prices. From its own peak in May of last year at around $79.50, the stock has dropped nearly -40% to its current level below $50. 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 (Devon) is an independent energy company engaged primarily in the exploration, development and production of oil, natural gas and natural gas liquids. Devon’s operations are focused onshore in the United States with five core areas: the Delaware Basin, Eagle Ford, Powder River Basin, Anadarko Basin and Williston Basin. Its Delaware Basin operates approximately eight rigs that offers exploration and development opportunities from geologic reservoirs, including the Wolfcamp, Bone Spring, Leonard and Delaware formations. The Eagle Ford operations are located in DeWitt county, Texas. The Powder River Basin asset is focused on oil opportunities targeting several oil objectives, including Turner, Parkman, Teapot and Niobrara formations. The Company’s Anadarko Basin is located primarily in Oklahoma’s Canadian, Kingfisher and Blaine counties. The Williston Basin is located entirely on the Fort Berthold Indian Reservation consisting of approximately 85,000 net acres.DVN has a current market cap of about $31.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by about 19.4%, while revenue growth was flat, but positive, at 0.61%. In the last quarter, earnings declined by almost -24% while sales slid close to -21% lower. The company operates with a margin profile that, while still robust is showing signs of weakness. Over the last twelve months, Net Income as a percentage of revenues was 31.38%, and narrowed to 27.94% in the last quarter.
Free Cash Flow: DVN’s free cash flow is a sign of strength, at a little over $3.4 billion over the last twelve months. This is a decline over the past year, when Free Cash Flow was a $4.18 billion, as well as $5.5 billion two quarters ago. Its current level translates to a Free Cash Flow Yield of 11.03%.
Debt/Equity: DVN carries a Debt/Equity ratio of .55. This is a generally conservative number that suggests management applies a conservative approach to leverage. Their balance sheet shows $1.45 billion in cash and liquid assets against about $6.2 billion in long-term debt. It is worth nothing that two quarters ago, cash was nearly $3.5 billion.
Dividend: DVN’s annual divided is $5.06 per share, which translates to an impressive yield of about 10.59% at the stock’s current price. The company’s payout is a little over 50% of their earnings per share for the past year, however their healthy operating profile and generally healthy Free Cash Flow suggests that maintaining the dividend shouldn’t be a problem. I do think that continued, extended drawdowns of cash could force management to decrease their dividend payout, which makes liquidity on which it’s worth keeping a watchful eye.
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 $57 per share. That means the stock is undervalued, with about 18% upside from the stock’s current price, and a practical discount at around $45.50 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.
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 June of last year at around $79.50 to its low, reached earlier this month at around $44. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock has bounced off of that low point, marking current support at $44, and hit its latest pivot high at around $49.50 this week before dropping back a bit to its current level around $47. A push above $49.50 should have near-term upside to about $53 before finding next resistance, while a drop below $44 could see downside to about $38.50 to next support, using the current distance between support and resistance as a reference.
Near-term Keys: The stock’s trend and momentum right now is strongly bearish, implying that looking for a short-term, bullish trade right now is aggressive, and even speculative. That said, a push above $49.50 could be a signal to think about buying the stock or working with call options, using $53 as a useful, bullish profit target. A drop below $44 would be a good signal to consider shorting the stock or buying put options, with $38.50 acting as a useful near-term exit target. What about value? I like DVN’s fundamentals, but do see declining liquidity, combined with the stock’s long-term downward trend as risk elements that I think warrant taking a conservative approach right now and waiting for further signs of stabilization before looking for a new, value-based opportunity.