Devon Energy Corporation — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; comparisons are to the corresponding 2016 periods unless noted. Amounts are in U.S. dollars.
Business context and results
Devon is an oil and gas exploration and production company with U.S., Canadian and EnLink midstream operations. Management emphasized investment in the STACK and Delaware Basin, cost control and maintaining financial strength.
- Q2 revenue and other: $3.273 billion, up from $2.488 billion. Oil, gas and NGL sales were $1.206 billion; marketing and midstream revenue was $1.927 billion.
- Q2 earnings: Operating income was $542 million, versus an operating loss of $1.497 billion in Q2 2016. Net earnings attributable to Devon were $425 million, or $0.80 per diluted share, versus a $1.570 billion loss, or $3.04 per diluted share.
- First-half earnings: Revenue and other was $6.820 billion; operating income was $1.248 billion; net earnings attributable to Devon were $990 million, or $1.87 per diluted share. First-half 2016 included a $4.532 billion asset impairment charge and a $271 million restructuring and transaction charge.
- Core earnings (non-GAAP): $177 million, or $0.34 per diluted share, in Q2; $394 million, or $0.75 per diluted share, in the first half. These exclude specified items and should be considered alongside GAAP results.
- Production and prices: Q2 total production was 536,000 Boe/d, down 17%; retained production was down 7%. Realized price excluding derivative effects rose 34% to $24.72/Boe. For the first half, production was down 17%, while realized price rose 60% to $25.28/Boe.
- Costs and margins: Q2 lease operating expense was $399 million, down 4%, but LOE per Boe rose 15% to $8.18. Marketing and midstream operating profit was $224 million, up 8%; management attributed the improvement mainly to higher EnLink throughput, partly offset by weaker margins on Devon downstream commitments. Those commitments were expected to weigh on margins through 2017.
- Cash flow and investment: Operating cash flow was $810 million in Q2 and $1.644 billion in the first half, versus $345 million and $510 million, respectively, in 2016. First-half capital expenditures were $1.468 billion; capital expenditures including acquisitions were $1.538 billion. Management said operating cash flow funded all capital expenditures in the first half.
Financial position and liquidity
- At June 30, cash and cash equivalents were $2.369 billion, current assets $4.086 billion and current liabilities $2.532 billion.
- Long-term debt was $10.558 billion, compared with $10.154 billion at December 31, 2016. Devon reported no borrowing under its $3.0 billion senior credit facility, with approximately $2.9 billion available after letters of credit. Its covenant debt-to-capitalization ratio was 19.3%, against a 65% maximum.
- EnLink and General Partner debt was non-recourse to Devon. EnLink had $3.697 billion of debt; its facilities included $166 million borrowed under its $1.5 billion revolver and $65 million borrowed under the General Partner’s $250 million facility.
- Devon reported no significant debt maturities until 2021. S&P rated Devon BBB with stable outlook; Fitch affirmed BBB+ and moved its outlook to stable; Moody’s upgraded it to Ba1 with stable outlook.
Material changes and unusual items
- Improved commodity prices were the main driver of higher revenue, operating margins, earnings and cash flow. Price-driven sales increases outweighed lower production volumes.
- Q2 oil, gas and NGL derivative results included a $115 million fair-value gain and $11 million of cash settlements; the income statement reported $126 million of derivative gains. Derivative fair values can materially affect reported earnings without corresponding period cash receipts.
- Compared with the prior year, results benefited from the absence of 2016’s large oil and gas impairments, EnLink goodwill impairment, and workforce-reduction and transaction charges.
- Devon reduced estimated asset retirement obligations by $184 million in the first quarter, primarily due to revised assumed inflation rates and retirement dates.
- EnLink issued $500 million of 5.45% senior notes due 2047 and redeemed $163 million of 7.125% notes, recording a $9 million gain on extinguishment.
Outlook, commentary and risks
- Management forecast Devon’s highest-margin retained U.S. oil production to exit 2017 at a rate 18%–23% above year-end 2016, citing improved well productivity and increased drilling. It said this would support momentum into 2018.
- Management’s priorities were to build activity in the STACK and Delaware, fund capital programs organically, complete asset sales and strengthen the investment-grade balance sheet. Devon planned to concentrate capital in the STACK and Delaware and invest within cash flow.
- Devon’s 2017 capital expenditures, excluding EnLink, were forecast at $2.2–$2.6 billion, including $1.9–$2.2 billion for exploration and development.
- Devon targeted hedging about 50% of production. At June 30, approximately 55% of forecast remaining-2017 oil production was hedged at an average floor of $50/Bbl and approximately 55% of gas production at $3.10/MMBtu; management said it was building 2018 hedges at similar prices.
- A $1 billion non-core upstream divestiture program was announced, with proceeds intended for resource-play investment and balance-sheet strength. The filing said an Eagle Ford sale for $205 million was agreed after quarter-end and expected to close in the second half of 2017; combined with other sales, $340 million had been sold under the program. The broader process was expected to take 12–18 months.
- Key risks include volatile commodity prices, reserve-estimation and development uncertainty, hedging and counterparty risks, regulation and environmental obligations, indebtedness, divestiture execution, midstream constraints, competition and cyberattacks. A 10% change in commodity forward curves would have changed net derivative asset positions by about $150 million. Management reported no material change in the risk factors from its 2016 Form 10-K.
- Devon maintained a 100% valuation allowance against U.S. deferred tax assets and a partial allowance against certain Canadian deferred tax assets. The filing also noted ongoing tax audits and uncertainty over their resolution and payment timing.
Most important facts for investors to verify
- Whether expected retained U.S. oil production growth and the planned capital program are achieved within operating cash flow.
- Realized commodity prices, production trends and the effect of hedges—including fair-value movements—on earnings and cash generation.
- Progress, timing and proceeds from the announced divestiture program, and use of proceeds to fund investment or reduce financial risk.
- Debt and liquidity trends, including EnLink’s non-recourse debt, the remaining $250 million acquisition installment due by January 2018, and covenant compliance.
- Whether downstream marketing commitments, Canadian transportation tolls, tax valuation allowances, and environmental or royalty matters develop differently from management’s expectations.