Devon Energy’s relative valuation
Let’s take a look at some of the fundamental ratios for S&P 500 (SPY) upstream companies with similar production mixes and overlapping geographical areas of operation.
Devon Energy (DVN) has a forward EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) ratio of ~13x, which is much lower compared to other crude oil producers from the Eagle Ford Shale such as Pioneer Natural Resources (PXD). PXD has a forward EV-to-EBITDA ratio of ~17x.
EOG Resources (EOG), a crude oil producer that operates in the unconventional resource space, has a forward EV-to-EBITDA ratio of ~20x. DVN’s forward EV-to-EBITDA of ~13x is much lower than EOG’s.
Compared to offshore players such as Murphy Oil (MUR) and Noble Energy (NBL), DVN’s forward EV-to-EBITDA is higher. These companies have forward EV-to-EBITDA ratios of ~8x and ~10x, respectively. DVN’s valuation appears to be in the middle of the range compared to its peers. The average EV-to-EBITDA ratio for the upstream industry is ~11.1x.
Even when comparing price-to-book values, DVN appears to be in the middle of the range at ~1.56x. On a price-to-sales basis, DVN is much cheaper at ~0.92x
Is DVN’s multiple justified?
Typically, companies with lower leverages or higher current ratios trade at premiums to their book values or have higher price-to-sales ratios. A possible explanation for this could be fear of an energy-driven debt crisis if commodity prices stay low for much longer than anticipated.
As of 4Q15, DVN has a high debt-to-equity ratio of ~120% and a low current ratio of ~1.22x. However, DVN is also actively engaged in the divestiture of its non-core assets, with the intent to divest $2 billion–$3 billion worth of assets in 2016. DVN is planning to use the proceeds from its divestitures to reduce debt.
Given its high debt and the possibility that it will reduce this debt in 2016, DVN’s trading at a mid-range multiple is justified.