Devon Energy (DVN) Update - July 7

[dan_s]

From RBC Capital Markets July 6, 2021
Devon Energy Corporation (DVN) is trading at $27.54 at the time of this post. RBC's price target is $35, which compares to my valuation of $48.
Quarterly Check-Up: 2Q21

Our view: We have updated our 2Q21 estimates to reflect final commodity
prices and made other changes to our model based on our channel checks,
data analytics, and conversations with the company. Merger synergies are
looking favorable, biasing our costs down a bit. The story is mostly on DVN
sticking to maintenance activity, providing a runway for strong variable
dividends. We model the 2Q21 quarterly variable dividend at $0.30-0.32/
share, up from $0.23/share in 1Q21.

Key points:
• Our 2Q21 EPS/CFPS estimates increased by $0.05/$0.09 to $0.54/$1.55
reflecting final 2Q21 benchmark commodity prices and other tweaks
to our model. Our estimates are above the $0.48/$1.41 Consensus and
marginally higher than implied midpoint guidance. < My forecast is Q2 EPS of $0.67 and operating CFPS of $1.66. Note that my EPS forecast and RBC's EPS forecast do not include the mark-to-market adjustments on hedges. "Adjusted Net Income" is what all analysts forecast .
• We model production at 560 Mboe/d (292 Mb/d oil), above Consensus
at 553 Mboe/d (291 Mb/d oil) and near the high end of DVN's 538-561
Mboe/d (283-293 Mb/d oil) guidance. DVN has a track record of
meeting to exceeding guidance which we expect continues mainly driven
by persistent asset outperformance in the Delaware Permian, where
completion activity was robust in 2Q21. < My forecast assumes Q2 production of 545 Mboe/day.
• Our capital spending estimate of $550 million, just below the midpoint
guidance of $530-590 million. This drives FCF generation of $500 million.
2Q21 should be the annual high point for spending due to a high amount
of Delaware completions. This should also drive stronger FCF into 2H21.

Channel checks & investments themes:
• Our 2022/2023 EPS/CFPS estimates decline, reflecting a more modest
growth assumption than we previously modeled and a few other slight
tweaks. Importantly, our FCF estimates through 2023 increased slightly.
DVN remains steadfast with its growth targets and does not appear to
contemplate any activity ramp until at least early 2022. We now model
production growing by 4% entry-to-exit in 2022, in line with DVN's 0-5%
growth framework. Supply-demand fundamentals govern when DVN
could look to modestly grow within its up-to-5% oil growth framework. < My forecast is that Devon's production will increase more in 2022 because I believe oil & gas prices will be higher and too tempting for Devon to stick to "maintenance mode". Even if I assume only 5% YOY production growth in 2022, my valuation is still over $45.
• The Delaware is likely where first growth capital gets deployed if/when
supported by market fundamentals.
• Anadarko basin production should increase meaningfully with five non JV
completions and restarts post the 1Q21 winter storms.
• We think DVN could look to boost the max variable payout ratio by early
2022. The company may also evaluate increases to its fixed dividend.
• DVN is seeing service/raw material cost inflation that could push 10%
in 2H21, these items only represent roughly 10-15% of the budget,
however, and are already assumed in the 2021 outlook.
• Leverage is trending toward management's 1.0x or better target by YE21.
We expect DVN continues to opportunistically reduce gross debt over
time; however, with the maturity runway now farther dated and callable
options more expensive, this could translate to more cash building to the
balance sheet or being put toward shareholder returns