Hidden Gem Among Unloved Energy Stocks?

Anyone doing even a cursory review of trends in profits for the second quarter of the year now that the earnings season is on the verge of wrapping up might understand why investors are at best lukewarm in their enthusiasm for energy companies. While the financial stocks reported a 30% jump in profitability for the quarter, and consumer discretionary companies announced an 8.5% advance, the energy sector has been the worst performer among the 10 S&P 500 sectors, posting a decline of 8.5% in earnings.

^DJUSOG Chart

^DJUSOG data by YCharts

That may help to explain why the attitude to companies like Devon Energy (DVN) has been less than enthusiastic of late, even though the company just reported a 43% increase in net income to $1.68 a share for the second quarter.

That reflects the higher commodity prices in the three-month period as well as the company’s flexibility in adjusting its production output to take advantage of the fact that, while natural gas prices still linger at depressed levels, it is able to generate higher profits from its crude oil projects: crude output rose 14% in both the first and second quarters of 2013.

Nonetheless, the stock price is up only slightly more than 1.2% since those earnings were announced on August 7, reflecting investors’ wariness of the energy sector as a whole. That’s because Devon is still viewed primarily as a natural gas play.

True, commodity prices offer a significant headwind to all the companies in the exploration and production segment of the energy industry.

But not only does Devon Energy remain relatively undervalued, based on PE ratio -- compared to Noble Energy (NBL), Cabot oil & Gas (COG) and EOG Resources (EOG) -- but it has avoided a trap into which many of its peers have tumbled: over-committing to costly expansion projects at the top of the market, only to see its revenues from those new sources of production drop just as it requires extra cash to cover the project costs.

DVN Forward PE Ratio Chart

DVN Forward PE Ratio data by YCharts

Moreover, there is some potential good news looming on the horizon. Devon has announced its intention to spin off its midstream businesses of gathering and processing natural gas into a master limited partnership, which would then be sold to the public in an IPO before the end of the autumn, depending on market conditions. Several analysts view this as a good way to unlock the value of these assets as well as of generating capital that can be used to fund Devon’s ongoing operations or to pick up additional acreage in promising regions at a time when some of its rivals are having to scale back their own spending.

If taking the plunge on the upstream exploration business that will remain at the heart of Devon’s business model still seems to risky, investing in the MLP is another option to ponder, offering a lower risk and potentially appealing cash flow.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Company Analysis  energy stocks   stocks that look cheap   

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