By Sven Olson
When U.S. natural gas producers release their 2012 annual reports, many companies may have to reduce a key indicator of their financial health: Reserves. Even though U.S. natural gas prices have bounced back slightly, the Securities and Exchange Commission (SEC) requires companies to calculate and report year-end oil and gas reserves using 12-month average prices. Last year, the average price for natural gas at delivery point Henry Hub was $2.77 per million British thermal units, 30% below the previous year’s level, as production from shale gas fields continued to depress prices. This sharp markdown in price will result in big cuts to estimates of proved reserves. Reserves are important because they are used in establishing the value of a company and often used in pricing loans.
Devon Energy Corporation (NYSE:DVN) has already taken gas reserves off its books. A Thomson Reuters StarMine analysis shows that analysts’ 2013 profit estimates for major U.S. gas producers have been cut sharply in the past month and this pessimistic outlook indicates no dramatic recovery in natural gas prices is expected in the near term. However, with the U.S. winter set to be colder than the unusually warm one last year, there could be some correction of the supply/demand disparity on the back of its use for space heating by residential/commercial consumers. This could improve the prices and boost natural gas producers.
Analyst Ratings
Zacks has upgraded its recommendation on Devon Energy to “Neutral” from “Underperform”. There are several reasons for this upgrade stemming from the third quarter of 2012. Devon’s earnings per share (EPS) were ahead of the Zacks Consensus Estimate, helped by lower marketing and midstream operating expenses and a decline in tax charges. Devon has shown discipline in the use of capital by efficiently allocating its resources to projects that are vital for its future growth.
Devon is focusing on its oil and liquids-rich opportunities, and most of its drilling programs are centered on oil-focused properties. Devon has also joined hands with international companies like Japan’s Sumitomo and China’s Sinopec to expand its portfolio, which will result in the improvement of its production capabilities and consequently financial results in the future. Devon has a strong liquidity position as well as operational efficiencies. This reflected in its cash balance of $5.3 billion as of September 30th, 2012 and third quarter 2012 cash flow of $3.8 billion generated from operating activities. This financial strength enables the company to execute the strategy of steady expansion. In addition, the company intends to merge its U.S. personnel into a single operations group and expects to complete this by the first quarter of 2013, which should result in overall operational productivity enhancement, improved employee synergy, and lower operating costs.
Oppenheimer reported that they have reduced their price target from $75 to $67. This price target suggests a 19% increase from the stock’s current price of $54.29. Analysts have lowered the company’s price target based on lower natural gas prices in the U.S. An analyst from the firm commented that, “Devon’s earnings and cash flow are highly leveraged to U.S. natural gas prices. It has 38% of its estimated 2013 gas production hedged at $3.90/mcf and 10% of its 2014 gas volume hedged at $4.09/mcf. Devon has $6 billion in foreign bank accounts and is waiting for potential tax reform before repatriating this cash, which could be used to fund a large buyback program to boost its stock price. Our estimates reflect updated commodity prices.”
Competitive Peers
Oppenheimer lowered its price target Chesapeake Energy Corporation (NYSE:CHK) from $28 to $24, but kept its “Outperform” rating to reflect lower than expected natural gas and NGL prices. JPMorgan upgraded shares of Chesapeake Energy by two notches from “Underweight” to “Overweight”. The firm’s upgrade is due to expected financial improvements and additional asset sales.
EnCana Corporation (NYSE:ECA) has a valuable portfolio of unconventional resource assets which are priced at a significant discount to their true value. These discounts stem from leveraged balance sheets, low natural gas prices, and the huge amount of cash needed to develop them. Two deals demonstrate this value: Petro China agreed to acquire a 49.9% interest in 445,000 of Encana’s Duvernay acres at a total purchase price of $2.18 billion, and Mitsubishi agreed to acquire a 40% interest in Encana’s Cutbank Ridge acreage at a price of $2.9 billion. Zacks Investment Research downgraded Talisman Energy Inc. (NYSE:TLM) to a Zacks Rank #5 (Strong Sell). The downgrade was prompted by a sharp decline in estimates on the back of disappointing third quarter 2012 results. The loss was mainly due to lower price realizations.
Zacks has reaffirmed its “Neutral” rating on Enbridge Energy Partners L.P. (NYSE:EEP) based on its complimentary position to reap benefits from its diversified business portfolio and stable fee-based operating income. However, a depressed natural gas price environment is expected to affect its stock price. The partnership is best known for its ownership of the Lakehead System, one of the world’s longest petroleum pipeline systems, which transfers over 60% of the Canadian oil output into the U.S.
In my opinion, Devon is fairly priced at current levels and I may buy on any near term dip.
Disclosure: No Positions
