Devon Energy Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; interim financial statements are unaudited. Dollar amounts are in millions unless stated otherwise. Devon’s continuing business is U.S. oil and gas exploration and production; Canadian operations and EnLink are reported as discontinued operations following their sales.
Financial performance and key metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $1,847 | $2,156 | $4,996 | $5,957 |
| Net earnings (loss) from continuing operations | $139 | $156 | $(41) | $(548) |
| Net earnings attributable to Devon, including discontinued operations | $109 | $2,537 | $287 | $1,915 |
| Diluted net earnings per share | $0.27 | $5.14 | $0.69 | $3.74 |
| Operating cash flow from continuing operations | $597 | $560 | $1,563 | $1,519 |
| Capital expenditures | $536 | $548 | $1,532 | $1,653 |
- Revenue and earnings: Q3 revenue fell 14% year over year, while continuing-operations earnings declined to $139 million from $156 million. Q3 GAAP earnings include a $30 million loss from discontinued operations; the prior-year quarter included a $2.6 billion pre-tax EnLink sale gain. Nine-month 2019 earnings include a $328 million discontinued-operations gain, including the Canadian divestiture gain.
- Cash flow and investment: Nine-month continuing-operations operating cash flow exceeded capital expenditures by $31 million. Q3 operating cash flow exceeded capital expenditures by $61 million. These simple differences exclude other investing and financing cash flows.
- Margins: Non-GAAP field-level cash margin was $652 million, or $16.57 per Boe, in Q3, versus $893 million, or $23.22 per Boe, a year earlier. Nine-month margin was $2.035 billion versus $2.475 billion. These measures are not GAAP profit margins.
- Production and prices: Total Q3 production averaged 428 thousand Boe/d, up 2% year over year; “New Devon” production was up 12%. Q3 unhedged combined realized price fell 24% to $25.93/Boe; with hedge settlements it was $27.73/Boe, down 6%.
- Liquidity and debt: At September 30, cash and cash equivalents were $1.375 billion, plus $280 million restricted for discontinued-operation obligations. Long-term debt was $4.295 billion, with no short-term debt; all debt was fixed-rate, averaging 6.0%, and no maturities were due before the end of 2025. The $3.0 billion revolving facility had no borrowings and $2 million of letters of credit outstanding. The reported debt-to-capitalization ratio was 18.9%, below the 65% covenant limit.
Material changes versus prior periods
- Revenue declined year over year, principally reflecting lower marketing revenue following asset divestitures and lower commodity prices. Q3 upstream revenue rose to $1.147 billion from $934 million, substantially affected by the change in unrealized and realized derivative results; the nine-month upstream revenue comparison also reflects derivative losses.
- Lower commodity prices weighed on results: Q3 2019 unhedged realized prices were down 16% for oil, 29% for gas and 59% for NGLs versus Q3 2018. Favorable hedge settlements partly offset the declines.
- Production growth in the Delaware and Powder River basins supported results, while lower Eagle Ford activity and reduced output from divested U.S. assets partly offset that growth. Production expenses fell 12% in Q3 year over year and 9% for the nine-month period.
- Q3 2019 net earnings attributable to Devon of $109 million compare with $2.537 billion in Q3 2018, primarily because the earlier period included the EnLink sale gain. Nine-month GAAP earnings comparisons are similarly affected by that prior-year gain and the 2019 Canadian sale.
- Devon sold its Canadian business in June 2019 for $2.6 billion net of purchase-price adjustments and recognized a $223 million pre-tax gain. In July it used proceeds to retire $1.5 billion of senior notes. Share repurchases totaled $1.746 billion in the first nine months of 2019; the company had repurchased $4.7 billion of its $5.0 billion authorization by September 30.
Outlook, management commentary, risks and unusual items
- Management described its strategy as building “New Devon,” a U.S.-focused upstream company with a returns-driven approach. It reported more than $200 million of annualized G&A savings expected by year-end 2019, approximately 10% lower capital expenditures while drilling 10% more wells than in 2018, and $60 million in annualized financing-cost reductions following debt retirement.
- Fourth-quarter 2019 exploration and development spending was expected to be $375 million to $420 million, excluding Barnett Shale assets. Management said capital spending would be adjusted to cash-flow conditions and focused on returns.
- Devon was evaluating a sale, merger or spin-off of its Barnett Shale assets and expected to complete their separation by year-end 2019. At September 30, those assets had an approximately $1.4 billion carrying value and represented about 46% of U.S. proved reserves. No impairment was recorded, but management said a sale at then-current market estimates would likely require an impairment.
- After quarter-end, Devon agreed to form a Delaware Basin midstream partnership. Devon will contribute Cotton Draw gathering and compression assets for a $100 million cash distribution; the partner committed $40 million of expansion capital.
- For the remainder of 2019, approximately 75% of expected oil production and 45% of expected gas production were hedged. Management identified commodity-price volatility as a major cash-flow uncertainty. A 10% change in derivative-related forward curves was estimated to change net derivative positions by about $130 million.
- Other notable items include approximately $280 million of restructuring and asset-impairment-related charges associated with the Canadian sale, partly reimbursed by the buyer; $73 million of restructuring expense in continuing operations during the first nine months; and a $37 million reduction in lease assets and liabilities from lease terminations in Q3, including $9 million of other expense.
- Risks include commodity-price and reserve-estimation uncertainty, hedging and counterparty exposure, regulatory and environmental matters, midstream constraints, indebtedness and potential asset impairments. Management identified the STACK as the asset most likely to face a material impairment if prices remain depressed and planned investment is materially reduced. Devon reported no material change to its previously disclosed risk factors. It said legal matters, including royalty claims and Louisiana coastal-zone litigation, were being defended and were not expected to be material after recorded accruals, although outcomes could differ from estimates.
Important facts for investors to verify
- Track realized oil, gas and NGL prices, hedge settlements and coverage, and how much protection remains after 2019.
- Assess whether production growth and cost reductions can offset weaker commodity prices, particularly in the Delaware and Powder River basins.
- Confirm completion terms and proceeds for the Barnett separation, and assess any resulting impairment against its reported carrying value.
- Monitor free cash flow against capital spending, share repurchases, dividends and debt reduction; distinguish unrestricted cash from the $280 million restricted balance.
- Review the final Canadian sale settlement and remaining tax, restructuring, transportation-contract and lease-abandonment obligations.
- Consider rating-agency outlooks: S&P and Fitch were negative, while Moody’s was positive; any downgrade could increase collateral or letter-of-credit requirements.