Devon Energy Corp Unlocks Significant Value by Unloading Its Midstream Business

Last fall, Devon Energy (NYSE: DVN) unveiled its 2020 vision, which is a strategy to transform the shale driller into a value-creating machine for investors. One phase of that plan is to sell non-core assets to strengthen its balance sheet and bolster its ability to create more value as the company looks to unload more than $5 billion in assets over the next few years.

The company took a major step in that direction this week after announcing that it had agreed to sell its stakes in midstream companies EnLink Midstream Partners (NYSE: ENLK) and EnLink Midstream (NYSE: ENLC) for $3.125 billion in cash. The shale driller plans to use that cash to repurchase up to $4 billion of its shares through the end of next year, assuming this transaction closes. These moves could unlock significant shareholder value in the coming year.

Image source: Getty Images.

Drilling down into the deal

Devon Energy has agreed to sell its 64% interest in EnLink Midstream and its 23% interest in EnLink Midstream Partners to private-equity giant Global Infrastructure Partners. Devon Energy will receive $3.125 billion in cash, which values its midstream stake at 12 times cash flow. That valuation is worth noting since Devon Energy currently sells for about 7.2 times cash flow, which is a bottom-of-the-barrel valuation versus its peers.

Aside from the sizable cash infusion, this deal will have a significant impact on Devon Energy’s financial profile. First, it will reduce the company’s debt by 40% since Devon will no longer need to consolidate EnLink’s debt on its balance sheet. Further, by removing EnLink from the equation, Devon’s general and administrate expenses and interest costs will fall by about $300 million on an annual basis. As a result, it will improve the company’s overall balance sheet and profitability even though the company will lose out on EnLink’s cash flow and won’t use the cash proceeds to repay any debt at the corporate level.

Image source: Getty Images.

Crunching the numbers

In addition to improving Devon’s financial profile, this transition will unlock significant value for investors. As noted, the company is selling its stake in EnLink for 12 times cash flow and plans to use the proceeds to repurchase shares, which currently trade at slightly more than seven times cash flow. Because of that value disconnect, Devon Energy has the potential to buy back a stunning 20% of its outstanding stock if it completes the entire $4 billion authorization at the current stock price, or about 14% on the incremental $3 billion that it will repurchase as a result of this transaction. To put it another way, the company is trading about 9% of its cash flow to retire 14% of its outstanding shares.

The sheer size of Devon’s buyback has the potential to move the stock meaningfully higher over the next year, given what similar repurchase programs have done for rivals in the recent past. In late 2016, ConocoPhillips (NYSE: COP) announced plans to repurchase $3 billion in shares that it would fund by selling assets. The company completed that authorization last year and added another $2 billion to the program for 2018.

Those repurchases have helped reduce ConocoPhillips’ outstanding share count by 5%, which has helped fuel a stunning 50% surge in the company’s stock price since it first announced the buyback program. ConocoPhillips currently plans to buy back $7.5 billion in stock through the end of 2020, which should reduce its share count even further.

Anadarko Petroleum (NYSE: APC) also has unlocked significant value for investors since announcing a $2.5 billion share-repurchase program last fall. Anadarko now has repurchased more than 6% of its outstanding shares, which has catapulted its stock 55% over that time frame. Meanwhile, the company authorized another $500 million in share repurchases this year and could spend even more in the future, given that it’s generating significant excess cash flow at current oil prices.

Ample upside ahead

Devon Energy’s buyback program has yet to have much impact since shares are only up about 1% this year, even though it has already spent $204 million to buy back 6.2 million shares. For comparison’s sake, both ConocoPhillips and Anadarko are up more than 20% already this year. Because of that underperformance, Devon Energy could rebound significantly in the coming year as it continues buying back its dirt cheap stock, making it a top oil stock to consider buying now.

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

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