1 Energy Stock I'm Buying Today

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This article is part of ourRising Star Portfolios series.

The next stock I'm buying for my portfolio is Devon Energy (NYS: DVN) , a well-managed oil and gas exploration and production company with a diverse set of assets, a strong balance sheet, and cheap valuation.

Recent transformation
Over the last two years, Devon Energy has sold off its assets in the Gulf of Mexico, China, Azerbaijan, and Brazil for a total of $8 billion after tax. The company's aim is to focus on production in onshore North America.

Here's how Devon has fared in onshore North America over the last five years:

Year

Production (millions of barrels of oil equivalent)

Reserve Replacement (% of production replaced)

2006168233%
2007183198%
2008207269%
2009220223%
2010223175%

Source: Company's investor presentation.

From the table, it's easy to see that production and reserves have grown nicely. A reserve replacement ratio of 100% would mean that oil and gas are being replaced about as quickly as it is being produced. A ratio of 175% to 269% from the above table shows that Devon has been growing its reserve base much more quickly than it has depleted it over the past five years. This leads to more future cash flow, which can then fund more drilling projects and increase reserves even more.

If you recall, the assets outside of North America have only recently been sold. That means even while Devon was operating assets all over the world, it managed to grow production and reserves quite nicely in North America. Flush with cash from the asset sales and ready to focus on just the U.S. and Canada, Devon should have no trouble accelerating its growth.

Now, let's examine Devon's major assets:

  • Oil sands: Multiple Jackfish and Pike projects in Canada, each with an estimated ultimate recovery of 300,000 barrels of oil.
  • Lloydminster: 2.7 million net acres of oil in Alberta and Saskatchewan.
  • Barnett shale: 623,000 net acres in Texas with 7,000 risked drilling locations.
  • Woodford shale: 243,000 net acres in Oklahoma with more than 5,000 risked drilling locations.
  • Granite Wash: 63,000 net acres in Texas and Oklahoma with up to 200 million barrels of oil equivalent.
  • Permian basin: 1 million net acres in New Mexico and Texas with up to 1 billion barrels of oil equivalent.
  • Canadian exploration: 4 million net acres of Cardium (light oil), Viking (light oil), and Lower Cretaceous zones (liquids-rich gas).
  • New ventures: 1.2 million net acres in the Niobrara, Mississippian, Utica, Michigan, and Tuscaloosa shale plays.

Without counting the significant oil sands projects and other minor acreage positions not listed, the above list still yields almost 10 million net acres of land to develop. They include shale gas, conventional light oil, shale oil, and heavy oil plays. Even without leasing any more land, Devon has a massive drilling inventory just waiting to be developed.

So now, we see that Devon has built up its war chest from asset sales and has a huge collection of drilling locations on which to deploy that cash. Let's examine how it stacks up against some of its peers:

 Devon EnergyEOG Resources (NYS: EOG) Chesapeake Energy (NYS: CHK) Noble Energy (NYS: NBL) Anadarko Petroleum (NYS: APC)
TTM Operating Cash Flow$5.5 billion$4.0 billion$4.9 billion$2.3 billion$5.9 billion
Market Cap$26.6 billion$27.2 billion$17.7 billion$16.0 billion$41.1 billion
Net Debt$2.4 billion$3.8 billion$11.7 billion$2.6 billion$10.4 billion
Price / Operating Cash Flow4.96.93.67.07.0
P/B Ratio1.32.21.12.12.1

Source: S&P Capital IQ.

Based on the above table, the two stocks that stand out as the cheapest by both price/book ratio and price-to-operating-cash-flow multiple are Devon and Chesapeake. However, we see that Devon, despite its bigger market capitalization, has a net debt position of only $2.4 billion compared to Chesapeake's $11.7 billion. Devon's ability to generate cash is also quite impressive, generating almost as much operating cash flow as Anadarko despite being valued as a much smaller company.

Going forward, Devon plans on putting its recently acquired cash to work. The company plans to develop existing inventory, grow its oil and liquids production by at least 16%, and accelerate the exploration of many of its main acreage positions, especially in Canada and the Permian. If the company maintains a disciplined capital spending program, it should be able to grow production and reserves quite rapidly over the next several years.

Growing production, increasing reserves faster than they are depleted, and maintaining a strong balance sheet are all top goals of oil and gas producers, and it looks like Devon Energy is in prime position to do all of these things. As long as management continues to focus on disciplined capital allocation, the company should have a bright future ahead.

Foolish bottom line
The landscape of the North American oil and gas has changed drastically in just the last decade with the advent of the shale plays. In order to take advantage of the prolific production out of the U.S. and Canada, I have decided to add Devon Energy to my portfolio, an explorer and producer with a diverse set of assets, a strong balance sheet, and cheap valuation.

At the time this article was published Paul Chi owns shares of Chesapeake Energy. The Motley Fool owns shares of Devon Energy. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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