Devon Energy

Activist Toms Capital has pushed Devon to explore strategic alternatives, including a potential sale of the company. Toms joins a litany of other exhortations, including Kimmeridge, who've pushed Devon to quicken the pace of asset sales and better articulate a strategy following its Coterra merger.

Why it matters: Devon has frequently traded at a discount to both intrinsic and relative value over the last couple of years. Currently, Devon trades for roughly four and a half times 2027 EV to EBITDA, in a category that typically trades about a turn higher. We agree Devon should trade about a turn higher. We also agree that Devon should better articulate its postmerger strategy, in particular which assets it's prioritizing. While Devon issued undervalued equity, it did shore up inventory, which, when lower, can hurt multiples. But the market will discount producers with both oil and gas basins. But the pace of asset sales should depend on which assets it plans to sell. Gas trades below midcycle pricing, so negotiating in public or a fire sale when there aren't balance sheet issues or to satisfy short-term shareholders isn't ideal either.

The bottom line: We maintain our $56 fair value estimate and value the company at roughly five and a half times 2027 EV to EBITDA. For now, we also maintain our Exemplary Capital Allocation and narrow moat ratings, but we're watching asset sales closely as the acquisition's gas assets hurt future ROIC. Nonetheless, we still think the company has a track record of executing well on synergies and reconstituting its portfolio, so we're willing to exercise some patience. Reuters reported BP was previously interested in Devon's Eagle Ford assets at a price that would have made sense for Devon. These actions tell us that Devon is actively evaluating potential deals. But since the successful $1 billion business optimization plan didn't translate to a full rerating of the stock, we do think Devon's window to stand on its own is narrowing.

We marginally lift our fair value estimate to $56 from $55 for narrow-moat-rated Devon. We think the selloff here is an uncommon long-term opportunity in the energy space, and we think Devon has more runway. Devon could have a bigger upside than we've baked in if it executes incremental merger synergies.

While we generally eschew transformative mergers with undervalued stock as currency, we do like the focus on the Delaware Basin, given that it’s the source of Devon's moat and low-cost position, along with the attractive inventory runway. We think the Coterra deal adds roughly $4 per share to Devon's fair value.

We assume oil (West Texas Intermediate) prices in 2026 and 2027 will average $81 and $72 per barrel, respectively. In the same periods, natural gas (Henry Hub) prices are expected to average $3.10 and $3.49 per thousand cubic feet. Terminal prices are defined by our long-term midcycle price estimates (currently $65/bbl Brent, $60/bbl WTI, and $3.70/mcf natural gas).

Our fair value estimate corresponds to enterprise value/EBITDA multiples of 4.7 times for 2026 and 6.0 times for 2027. Our production forecast for 2026 totals 1,379 thousand barrels of oil equivalent per day, which is expected to drive 2026 EBITDA of approximately $12 billion. We expect free cash flow to be around $6.8 billion in the same period. Our 2027 estimates for production, EBITDA, and free cash flow are approximately 1,499 mboe/d, $9.6 billion, and $2.5 billion, respectively.

We think Devon merits a Narrow Morningstar Economic Moat Rating from cost advantages. It is a multibasin, US-based exploration and production company dedicated to the production of hydrocarbons in oil, natural gas liquids, and natural gas. However, a plurality of its production volumes comes from oil and natural gas. Hydrocarbons are commodity products and therefore don’t exhibit pricing power, switching costs, or other moat sources that depend on either meaningful differentiation or a market niche. So, moats are relatively rare in our E&P coverage. That said, we think low-cost E&P producers, or those that maintain production costs well below the industry’s long-term marginal cost, can command a moat over their higher-cost counterparts. Devon’s breakeven oil price of just under $44 a barrel falls well below our estimated marginal cost of production at $65/bbl Brent and roughly in line with the independent group average of over $44.50/bbl.

Devon and other narrow-moat E&Ps maintain their cost advantage primarily through access to low-cost resources with intrinsically low extraction costs. In other words, location matters most to a company’s moat prospects. Relative to other US shale players in our coverage, Devon’s inventory boasts some of the lowest breakeven costs. In the Eagle Ford basin, for instance, Devon enjoys access to premium Gulf Coast pricing given its proximity to the area’s refining operations. Aside from benefiting from that basin’s inherently favorable geology, its advantageous location also drives premium margins through lower shipping costs.

Of Devon’s basins, the most critical is its presence in the Delaware. In fact, Devon commands one of the strongest presences in the Delaware, which represents roughly two-thirds of its overall production. The Permian nearly supplies the lowest breakeven costs among US shale basins. Supply costs are low in the Delaware due to favorable geology, allowing US shale players to extract above-average flow rates and recoverable reserves. This means well production is more efficient there relative to other plays.

While reservoir quality matters most, strong well performance is critical for E&P firms because it allows them to spread their fixed costs and elicit higher margins as volumes rise. We glean evidence of Devon’s status as a low-cost producer from its favorable unit economics. Devon delivers strong cash margins relative to peers, just behind narrow-moat firms Diamondback and EOG, which sit below Devon on the cost curve.

While Devon’s current asset mix favors the Delaware, this wasn’t the case before the merger with WPX in 2021. WPX brought a far greater presence in the Delaware and newfound exposure to the Williston Basin in the Bakken Formation. Previously, the Delaware typically only represented 10%-15% of Devon’s overall production. Devon also divested its Barnett Shale and Canadian oil sands assets, which were (and still are) less favorably positioned on the cost curve. Combined, the Barnett Shale and Canadian heavy oil represented roughly 40%-50% of Devon’s production prior to their sale. In 2026, Devon merged with Coterra, increasing its presence in the Marcellus, as well as increasing the natural gas portion of its total production to nearly 40%.

Consequently, we believe Devon’s reconstituted portfolio represents a much stronger asset mix today. Devon’s remaining inventory life in high-quality assets exceeds our 10-year horizon for a narrow moat. Furthermore, the entire US E&P industry has focused far more on generating excess returns on capital following a decade of overexpansion during the shale revolution. While absolute E&P capital expenditure has moved higher since the 2020 trough, reinvestment rates remain low relative to history.

Devon has similarly ramped up absolute levels of capital expenditures in the years following the pandemic-induced drop in oil prices. In fact, Devon’s reinvestment rate has averaged roughly 55%, while its organic investments regularly exceeded or approached 100% of its operating cash flow before 2018. We think Devon’s more recent record of prudent capital deployment, coupled with the remaining life of its current inventory, minimizes the chances that it overextends itself and pursues value-destructive growth.

Given Devon’s low-cost structure, our midcycle oil price of $65/bbl Brent would have to fall roughly 14% for the firm to start falling below our estimated cost of capital. This is a harsh exercise since we assume no incremental adjustments to production. We view a scenario where the price falls to these lower levels and stays there as unlikely. While we acknowledge a somewhat slim excess returns profile at midcycle, Devon’s low-cost structure, remaining quality inventory, and demonstrated willingness to make prudent capital investments give us sufficient confidence that the company can clear its hurdle rate over the next decade.

Devon enjoys ideally located acreage in core portions of the basins it operates in. Attractive acreage translates to above-average well performance and peer-leading supply costs.

Devon’s shareholder-friendly capital allocation plan opens the door for substantial returns to shareholders via a base dividend, variable dividend, and opportunistic buybacks.

By capping growth at 5% annually, Devon avoids the risk of overspending during upcycles, a common fault of many upstream firms.

After incorporating sunk costs from leaseholds, acquisitions, exploration, and infrastructure, Devon's capital base inflates to a level that could threaten excess returns.

Devon’s profitability in the Permian can’t be matched in other parts of its portfolio.

Production growth could periodically outpace midstream capacity additions in the Permian, creating bottlenecks like Devon has faced historically.