Devon Energy Shares Tumble After Q4 Production Issues

Severe winter weather was a huge drag on Devon’s DVN fourth-quarter financial and operating results. Production came in below the low end of management guidance, capping earnings below Wall Street estimates (EBITDA and adjusted EPS were 3% and 4% respectively, below FactSet consensus estimates). And to make matters worse, management now expects Delaware Basin infrastructure outages and other constraints to crimp first-quarter volumes in the region by 10, 000 barrels of oil equivalent per day (2%). The announcement triggered a 12% decline for Devon shares and probably exacerbated a sectorwide selloff as investors weighed the potential read-through for peers operating in similar areas that have yet to report fourth-quarter results.

The 2023 outlook was disappointing as well. Management anticipates year-on-year volume growth of 7%, which slightly exceeds the firm’s long-term target of 5%. This probably reflects strong execution delivering more bang for the buck and should not be interpreted as a U-turn on the firm’s prior commitment to modest growth and capital discipline. But the optics of targeting higher growth are not ideal, especially when inflationary pressures have forced management to plan for 35% more capital spending this year, as compared with 2022. While we were previously incorporating significant well cost inflation in our prior model, this surge in capital spending far exceeds what we were modeling.

As a result, we have decreased our fair value estimate by $3 per share to $45. That means shares are still overvalued, even after the post-earnings slump. We continue to suspect that equity markets are discounting higher midcycle prices for crude oil than we are (our estimate is $55/bbl for WTI). Further, Devon’s 4,500-location risked drilling inventory doesn’t give it the same runway that some of its peers have.