Devon Energy Corp (NYSE: NYSE:DVN) reported its first quarter results on May 5 and it was a bit uninspiring. DVN reported a net loss of $3.6 billion during the first quarter, compared with the profit of $324 million that the company reported during the same quarter a year ago. In addition, it reported total operating revenues of about $3.27 billion for the quarter, compared with the $3.73 billion it generated during the prior year quarter. These results certainly raise a question of if investors can still trust this company. Let’s look a bit into the company to see.
For what it is, it would be unfair to single out Devon for criticism. Investors have to understand that it would be quite difficult to be profitable in the current oil and gas landscape. For the sake of reference, its close competitor Chesapeake Energy Corporation (NYSE: NYSE:CHK) reported a net loss of $3.782 billion for the first quarter. The main reason for the glut of losses in the oil and gas space is that oil companies usually have a set minimum crude oil price upon which they commission their exploration projects – in order to be profitable.
And with crude oil having declined over 50 percent over the past year, it would be extremely difficult for oil explorers to remain profitable. While this a red light, investor should focus on other performance metrics for now, as the situation right now is a bit above the control of the company. Moreover, with oil prices largely determined by demand and supply trends, the oil market debacle certainly won’t last long, since the current oil boom will also not last forever. We’ll only have to wait to see how long that would be.
In the meantime, let’s focus on some features of Devon that shows that the company can survive even if oil prices never quite return to pre-July 2014 levels.
Cost savings Initiatives
The company said in the first quarter report that it was able to reduce operating cost by nine percent on a year-over-year basis. Beyond the fact that an overall reduction in operating cost is great on its own, investor also need to appreciate that the company was able to effect the cost reduction “across all regions of the company’s portfolio.”
In addition, that Devon was able to achieve such cost saving while doing record production is impressive. If nothing else, it shows that the company has a working strategy for reducing its costs. If there is one thing that the current situation in the oil market has taught us, it is that oil companies have to work on cutting their cost – consciously. I believe Devon is nailing it on this front. You’d understand this by thinking about the benefits of seeking out really convenient mortgage terms from firms like BB&T Mortgage (NYSE:BBT). Following the cost reduction in the first quarter, the company says it now expects a cash cost savings of about $170 million for the entire 2015. If Devon can continue with such cost reduction across all of its portfolio, then it’s certainly molding itself into a value play.
Focusing on low-cost high yield assets
Having experienced cost reduction across all of its portfolio, one thing that is evident is that the company is focusing its business on low-cost high-yield assets.
Hedge fund manager Daniel Loeb echoed this point in its latest letter to investors.
“We believe the company has significant scope for improvement on operational execution as management begins to focus its capital in fewer, higher return areas,” wrote Loeb.
Loeb was specifically referring to three areas including the Permian Basin, the Eagleford shale and the CanaWoodford.
Again, this sort of discipline to focus only on high-return areas shows that company has what it takes to survive in a sector where falling prices necessitates cost reductions. Following the first quarter result, the company says it now expects its capital spending to be between $3.9 and $4.1 billion compared to the previous guidance of $4.1 to $4.4 billion.
Loeb’s hedge fund increased its position in Devon to benefit from the company’s improving operational efficiency. Third Point isn’t the only Hedge fund that thinks Devon offers a value proposition. Soros Fund Management LLC, which manages George Soros’ investments, initiated a position in the energy company during the fourth quarter of last year. For Soros’ Fund to have done that in a period where investing in oil-related companies is discouraging only goes to validate what Loeb says – in my opinion.
Below is a list of ten notable institutional investors that have taken advantage of declined oil prices to buy (more) shares of Devon.
Source of Funds’ information: Octafinance Hedge Funds Database
Investor Takeaway
Since the start of the decline in oil prices, DVN stock has fallen from close to $80 per share to the region of $65 per share. Factoring the cost saving initiatives of Devon with its focus on operational efficiency through high-return areas, I believe the dip presents an opportunity to buy at a discount for long-term gains.