Business context and reporting period
Devon Energy Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018. Devon’s continuing business is oil and gas exploration and production in the U.S. and Canada. Following the July 18 sale of its EnLink and General Partner interests, those midstream operations are reported as discontinued operations.
Financial and operating performance
- Revenue: Q3 continuing-operations revenue was $2.579 billion, up from $1.933 billion in Q3 2017. Upstream revenue was $1.332 billion; marketing revenue was $1.247 billion. For the first nine months, revenue was $7.026 billion versus $6.498 billion.
- Profit: Q3 net earnings attributable to Devon were $2.537 billion, or $5.14 per diluted share, compared with $193 million, or $0.37 per diluted share, a year earlier. Q3 continuing-operations net earnings were $300 million ($0.61 per diluted share), versus $194 million ($0.37) in Q3 2017. The nine-month period showed a continuing-operations loss attributable to Devon of $385 million ($0.76 per diluted share), but total net earnings attributable to Devon of $1.915 billion ($3.71 per diluted share).
- Discontinued operations: Q3 included a $2.6 billion pretax gain ($2.2 billion after tax) from the EnLink and General Partner sale. Nine-month discontinued-operations earnings attributable to Devon were $2.3 billion.
- Core earnings: Management’s non-GAAP Q3 core earnings attributable to Devon were $324 million, or $0.65 per diluted share. Core earnings exclude specified items and are not a substitute for GAAP results.
- Cash flow and investment: Q3 operating cash flow from continuing operations was $807 million, compared with $501 million in Q3 2017; the nine-month total was $1.686 billion versus $1.656 billion. Nine-month capital expenditures were $1.851 billion, up from $1.298 billion. The filing does not provide a clear operating-margin measure.
- Liquidity and debt: At September 30, cash and cash equivalents were $3.102 billion and total debt was $6.048 billion, including $257 million classified as short-term. Devon reported $2.9 billion of available credit under its then-current $3.0 billion revolver and no revolver borrowings. Its debt-to-capitalization covenant ratio was 21.5%, within the 65% limit. The company said it had no significant debt maturities until 2021.
- Production and pricing: Q3 total production averaged 522 thousand Boe/d, down 1% from Q3 2017; retained-asset production averaged 500 thousand Boe/d, up 7%. Q3 realized price was $33.50/Boe before hedges and $31.61/Boe after hedges.
Material changes versus comparable periods
- Q3 total net earnings rose sharply, principally because of the EnLink and General Partner sale gain; continuing-operations earnings also increased year over year.
- Nine-month total net earnings increased from $715 million attributable to Devon in 2017 to $1.915 billion in 2018, while continuing operations moved from $714 million of net earnings to a $385 million loss attributable to Devon. The sale gain and other discontinued-operation results drove the difference.
- Higher oil and NGL prices supported upstream results, while commodity-derivative losses and higher production expenses were significant offsets. Nine-month production expenses rose 23% to $1.669 billion.
- Devon adopted ASC 606 in 2018. Certain gas-processing arrangements shifted to gross revenue and expense presentation, increasing Q3 revenue and production expense by $64 million and nine-month amounts by $191 million, with no effect on earnings.
- Devon repurchased $2.2 billion of shares through September 30 and reduced long-term debt by approximately $830 million. It recorded a $312 million loss on early debt retirement during the first quarter.
Outlook, management commentary, risks and unusual items
- Management maintained its 2018 capital expenditure forecast and expected Q4 2018 capital expenditures of $555 million to $665 million, including $550 million to $650 million for upstream activity. Capital allocation was focused on the STACK and Delaware Basin, with a stated objective of investing within cash flow.
- Devon reported approximately $4.7 billion of asset-sale proceeds and a $5 billion divestiture target. It expected announced Delaware Basin and Barnett transactions totaling about $320 million to close in Q4 2018; a further $100 million sale agreed after quarter-end was expected to close in Q1 2019.
- The $4.0 billion share repurchase program expires December 31, 2019. Devon had executed $2.6 billion through October 31 and expected to complete the program by early 2019. The quarterly dividend increased 33% to $0.08 per share beginning in Q2.
- Management said roughly 75% of expected oil production and 50% of expected gas production for the remainder of 2018 were protected by hedges. It was building 2019 and 2020 hedge positions at market prices. A 10% change in commodity forward curves would have changed the net derivative position by approximately $500 million.
- After quarter-end, wider Canadian heavy-oil differentials pressured realized prices. Devon reduced Jackfish production in November, with an expected Q4 impact of about 8,000 Bbl/d, and said further curtailments could follow if low prices persisted.
- Other notable items included $156 million of nine-month asset impairments, $105 million of restructuring and transaction costs, and a $34 million pension settlement expense. Cost-reduction initiatives were expected to generate $110 million of annualized savings.
- Key risks identified include commodity-price volatility, reserve-estimation uncertainty, operational and regulatory risks, hedging and counterparty risks, indebtedness, midstream capacity constraints, and execution of acquisitions or divestitures. Devon said it was not aware of material pending legal proceedings; it did not believe royalty or environmental matters were expected to create material exposure.
Important facts for investors to verify
- Separate recurring continuing-operations performance from the substantial EnLink sale gain and other discontinued-operation effects.
- Review the assumptions behind management’s non-GAAP core earnings and the reconciliation to GAAP results.
- Confirm actual completion proceeds and gains from the announced asset sales, including post-quarter transactions, and progress toward the $5 billion divestiture target.
- Track execution of the remaining share repurchase authorization, its funding, and the effect on share count and liquidity.
- Monitor Canadian heavy-oil differentials, Jackfish curtailments, production trends, and the coverage and fair-value exposure of commodity hedges.
- Assess debt maturities, refinancing and covenant capacity; the filing notes that a new $3.0 billion revolver was entered into on October 5, 2018, after quarter-end.