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4 Reasons Devon Energy's CEO Believes His Stock Is a Buy

Matthew DiLallo, The Motley Fool

Devon Energy (NYSE: DVN) has spent the past few years transforming into an oil growth machine. The company sold off most of its legacy natural gas assets and used some of the proceeds to buy land in several of the top oil-rich shale plays. While the oil producer still has a few more properties to part with, the new Devon is starting to emerge.

CEO Dave Hager fully believes that the repositioned company can create significant value for investors. He laid out Devon's value proposition on the fourth-quarter call, detailing four reasons investors should own the company's stock.

A person yelling into a bullhorn with money coming out the other side.

Image source: Getty Images.

1. We have a top-tier, oil-focused portfolio

Hager led off the call by stating:

Today we are unveiling a New Devon. We have been signaling strongly to the market for some time that when our U.S. oil assets achieve operating scale, exiting Canada and the Barnett is our path forward. What we present to you today is the culmination of an exhaustive strategic and operational review. The results, we believe, will put Devon in a position to become a consistent upper-echelon performer driving durable improvements in shareholder value. We have the assets and we have the team to do this. In short, we are aggressively reshaping Devon to win, and we will win.

By the end of this year, Devon will have streamlined its portfolio to just four assets: The Delaware Basin, the Powder River Basin, the STACK/SCOOP, and the Eagle Ford Shale. Hager also pointed out that these are "core of the core positions in the best U.S. oil plays." By focusing on its best assets, which are in some of the top drilling regions in the country, Devon believes it's well positioned to create significant value for investors going forward.

2. We can deliver healthy growth at low oil prices

One of the ways Devon intends on maximizing the value of its top-tier shale position is through its "unwavering commitment to a disciplined, returns-oriented growth strategy," according to Hager. He stated that "the leadership team at Devon fundamentally believes that a steadier and more measured investment program through all cycles is the best path to optimize corporate level returns, sustainably grow our business, generate free cash flow, and reward our shareholders with increasing amounts of cash returns." Because of that disciplined approach, Devon can grow its U.S oil production at a mid-teens annual rate on the cash flow it can produce at $46 oil, which is $4 below the baseline most peers use.

3. We intend on returning the bulk of our free cash to shareholders

Because Devon is set to run on the cash flows it can produce at $46 oil, it's positioned to generate significant free cash flow, given that oil is currently $10 a barrel above that level. However, Hager made it clear that "the benefits of higher commodity prices above $46 oil will drive higher levels of free cash flow for Devon's shareholders, not higher capital activity." In other words, instead of reinvesting its windfall from higher prices into drilling more wells, Devon plans to send that money back to shareholders. The company currently believes it can generate $1.6 billion of excess cash through 2021 at $55 oil, which is why it recently boosted its dividend 13% and added $1 billion to its industry-leading share repurchase program that has it on track to retire as much as 30% of its outstanding stock.

Oil pumps with money in the background.

Image source: Getty Images.

4. Our stock is an incredible bargain these days

One of the reasons Devon is buying back so many shares is its belief that they trade at "an incredibly attractive valuation," according to Hager. The company noted that its peers trade for an average of 6.8 times anticipated 2019 EBITDAX (earnings before interest, taxes, depreciation, amortization, and exploration expenses). With just the assets of new Devon on track to generate $2.5 billion in EBITDAX this year, it suggests that the go-forward business should be worth $16.8 billion. However, investors currently value the entire company, which includes the Barnett and Canada, at $15.7 billion, which implies a significant value gap. That's why Hager stated:

Bottom line is that we see a tremendous investment opportunity in Devon and we have put our money where our mouth is by aggressively buying back our stock over the past year. Devon represents a unique value proposition in the E&P sector that is recognized by the company and our board has authorized another increase in our share repurchase authorization to $5 billion. We will be actively buying back shares at this attractive valuation.

All the pieces are in place

Devon Energy has worked hard to transform itself into a low-cost oil and cash flow growth machine. It expects to complete the final stage this year, which sets the company up to deliver healthy production growth while generating boatloads of free cash flow that it intends on returning to shareholders. Those cash returns, especially the money spent on buybacks, could enable the company to generate strong total returns for shareholders, given how cheap the stock is these days. That upside is why Hager believes Devon's stock is a great buy these days.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.