When Peter Lynch coined the now famous term “invest in what you know”, he was thinking in terms of stock selection. However, this term can be broadly applied to what Devon Energy (DVN) announced today. Devon has decided to realign their capital investment focus to what they are best at; producing oil and natural gas fields onshore in North America. The large energy company announced today that they will sell their international and Gulf of Mexico assets in hopes of raising between $4.5 and $7.5 billion after tax in the process. The capital will then be put to work growing their domestic and Canadian onshore businesses and also to reduce debt. Devon believes that streamlining their focus should provide a boost to earnings, cash flow, production and reserves as early as 2011. Incidentally, that is the same timeframe in which Devon hopes to have the sales finalized.
The move is being met with optimism from the market and DVN is trading higher by about 5% on Monday afternoon. While the assets on the auction block account for 7% of the proven reserves (equivalent of 2.8 million barrels of oil) and 11% of production, the projects are comparatively quite expensive and require 29% of Devon’s capital expenditures budget. Clearly, redirecting this capital could yield tremendous benefits. There is no doubt that Devon is getting much more bang for their buck right now producing oil and natural gas onshore in North America.
Of course, speculation has begun as to who would be interested in purchasing the assets. The New York Times’ Dealbook speculates that this deal might attract some interest from the always energy hungry Chinese.
“One company that might be interested in taking the risk would be China National Offshore Oil Corporation, known as Cnooc. It recently agreed to buy a stake in some of Statoil’s Gulf assets, the first time that a Chinese company would take an ownership interest in energy assets in the United States.
Only four years ago, Cnooc’s $18.5 billion bid for American oil company Unocal collapsed under pressure from Congress amid concerns about American oil assets falling under the control of the Chinese government. Since then, the Chinese have been wary of bidding on American energy assets and have concentrated their investments on undeveloped fields at home and in Africa, the Middle East and South America.
The Statoil deal seems to have changed all that. But Devon’s assets could be too much, too soon for Cnooc. It may simply continue to buy small stakes in fields across the region before it is ready to make a major purchase.” — NYT’s Dealbook 11/16/2009
Although this deal may attract the Chinese firm like CNOOC (CEO), it will not be because of the dollar’s weakness in relation to the Chinese Yuan. The dollar has lost a lot of ground versus the Euro, but at least in the last year China’s currency has devalued as well and the relationship between the two is about the same as it was at the beginning of 2009.
Back to Devon, we think that this deal will likely improve our view of DVN stock, which we actually downgraded to Overvalued as of this week’s report. The company has been hit very hard by still weak natural gas prices and earnings and revenue have fallen off considerably. At the same time, the stock has appreciated by nearly 80% since March. By our methodology, we need to see fundamentals improve in order to justify a price increase of this magnitude, and as of yet it just has not been there. However, we have no complaints with this deal as it really should help Devon allocate resources more efficiently.