Devon Energy Corporation (NYSE:DVN) Q1 2023 Earnings Call Transcript May 9, 2023

Devon Energy Corporation beats earnings expectations. Reported EPS is $1.46, expectations were $1.38.

Operator: Welcome to Devon Energy’s First Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. This call is being recorded. I’d now like to turn the call over to Mr. Scott Coody, Vice President, Investor Relations. Sir, you may begin.

Scott Coody: Good morning, and thank you to everyone for joining us on the call today. Last night, we issued an earnings release and presentation that cover our results for the first quarter and our outlook for the remainder of 2023. Throughout the call today, we will make references to the earnings presentation to support prepared remarks, and these slides can be found on our website. Also joining me on the call today are Rick Muncrief, our President and CEO; Clay Gaspar, our Chief Operating Officer; Jeff Ritenour, our Chief Financial Officer and a few other members of our senior management team. Comments today will include plans, forecasts and estimates that are forward-looking statements under US Securities Law. These comments are subject to assumptions, risks and uncertainties that could cause actual results to differ materially from our forward-looking statements.

Please take note of the cautionary language and risk factors provided in our SEC filings and earnings materials. With that, I’ll turn the call over to Rick.

Rick Muncrief: Thank you, Scott. It’s a pleasure to be here this morning. We appreciate everyone taking time to join us. For today’s discussion, I’ll be focusing on three key topics that I believe are most important to our shareholders at this point. First, I plan to cover our solid first quarter execution. Second, I will run through the steps we’ve taken to bolster the return of capital to shareholders. And third, I plan to share insights on how our business is positioned to effectively control costs and gain momentum throughout the rest of the year. So to start off, let’s turn to our first quarter results on slide 6, where we had several key highlights. First, total oil production exceeded our midpoint guidance at 320,000 barrels per day, representing a growth rate of 11% compared to the year ago period.

This level of oil production was the highest in our company’s 52-year history. Our strong well productivity in the Delaware Basin was once again a key contributor to this result, and our recently-acquired assets, The Eagle Ford and Williston Basin also provided us higher volumes in the quarter. Clay will touch on our well productivity in greater detail later in the call, but I do want to highlight that the average well placed online in the quarter is on track to recover more than one million barrels of oil equivalent. These strong recoveries are right in line with our historic trends over the past few years, demonstrating the quality, depth and ability to deliver sustainable results across our resource base. Another notable achievement from the first quarter was our team’s effective cost management.

This was demonstrated by capital expenditures being in line with expectations and operating costs coming in better than our guidance by a few percent. I’ll cover this topic in greater detail later in the call with our outlook, but this positive start to the year puts us in a great position to potentially spend fewer dollars in 2023 to achieve our capital objectives for the year. With our first quarter capital activity, we limited reinvestment rates to prudent levels resulting in over $665 million of free cash flow. This marks the 11th quarter in a row our business has generated free cash flow, with oil prices over this time ranging from as low as $40 a barrel to as high as $120 a barrel. This is a great example of Devon’s ability to generate meaningful amounts of cash flow — free cash flow across a variety of market conditions, further showcasing the durability of our strategic plan to create value through the cycle and deliver returns on capital employed that compete with any sector in the S&P 500.

With this free cash flow, we continue to reward shareholders through our cash return framework, which was well balanced between dividends and stock buybacks in the most recent quarter. As shown on slide 7, the total cash payout from the shareholder-friendly initiatives reached an annualized rate of around a 12% yield in the first quarter, which significantly exceeds the available opportunities in other sectors of the market. Nearly half of this payout was derived from our distinctive fixed plus variable dividend framework. This consistent formulaic approach, which began almost three years ago has allowed Devon to offer one of the highest yields the entire S&P 500 since its groundbreaking implementation. Now turning to slide 9. In addition to our strong dividend payout, we continue to see attractive value in repurchasing our shares, which we believe traded a significant discount to our intrinsic value.

To capitalize on this compelling opportunity, we made substantial progress advancing our buyback program by repurchasing $692 million of shares year-to-date. In addition to our corporate buyback activity, multiple members of our management team, myself included, have also demonstrated their conviction in Devon’s value proposition by purchasing stock in the open market over the past few months. With our Board of Directors approving the upsizing of the capacity of our repurchase program by 50%, up to $3 billion, the company is well equipped to be active buyers of our stock over the course of the year. Now moving to slide 11. Looking to the remainder of 2023, there is no change to our disciplined operating plan we laid out for you earlier this year.

Now that our Delaware infrastructure is fully operational and actively ramping to place more wells online, we expect our production to grow over the remainder of the year. This momentum places us right on track to average just over 650,000 BOE per day this year, which translates into a healthy production per share growth of approximately 9% on a year-over-year basis. With capital, we’ve not made any revisions to our outlook of $3.6 billion to $3.8 billion for the year. As a reminder, this capital for cash assumes a low-single-digit inflation rate compared to our 2022 exit rate. However, in the first quarter, we did experience service stock – service price stability for the first time in many quarters, and we began to see signs of increased availability of goods and services due to an overall slowdown in industry activity.

If these trends continue, we see potential for downward pressure on service costs later this year and into 2024. With much of our contract book shifting towards shorter duration agreements, we’re now well positioned to work with our service partners for better terms as more frequent contract refreshment occurs over the next several quarters. Lastly, on slide 12, I believe this chart does a good job of summarizing the competitiveness of our outlook in 2023. With the plan we’ve laid out, we continue to possess one of the most capital-efficient programs in the entire industry that is self-funded at a $40 WTI oil price. With this disciplined plan, Devon is well-positioned to continue to generate significant free cash flow and execute all aspects of our cash return model, making 2023, another successful year for us.

Now with that, I will now turn the call over to Clay to cover our operational highlights. Clay?

Clay Gaspar: Thank you, Rick, and good morning, everyone. As Rick touched on earlier, our team did a great job of meeting the first quarter operational targets through solid well productivity, effective cost management and the steady progression of upcoming development projects that will benefit us over the coming quarters. Remember, we’re focused not just on delivering the numbers for this quarter and year, but also derisking opportunities for the coming years and also investing in R&D that will create value throughout the coming decade. We’re making great progress on all three fronts. This positive start to the year put us in great position to continue to build momentum throughout the course of the year and achieve our corporate objectives for 2023.

A significant contributor to the success in this quarter was our franchise asset in the Delaware Basin. As you can see on slide 15, roughly 60% of our capital was deployed to this prolific basin, allowing us to run a consistent program of 16 rigs and four frac crews in the quarter. With this level of drilling and completion activity, we brought online 42 new wells in the quarter, with the majority of this activity targeting high-impact intervals in the Upper Wolfcamp. This focused development program resulted in another quarter of volume growth year-over-year, with oil representing 51% of the product mix. While we had great productivity across our acreage position, our performance during the quarter was headlined by our Exotic Cat Raider project.

This 6-well pad located in Lea County, New Mexico, targeted a highly productive area with 3-mile laterals in the Upper Wolfcamp. Individual wells at Exotic Cat flowed at rates over 7,200 BOE per day and well — per well recoveries from this pad are on track to exceed two million barrels of oil equivalent. The flow rate from this activity rank among the very best projects Devon has ever brought online in the basin. And lastly, on this slide, another key event for us during the quarter was the resumption of operations at our Stateline eight compressor station. This was possible. Thanks to the team’s timely efforts in securing replacement equipment and the personnel to safely repair this critical facility. Although this repair work did temporarily limit our production in this part of the field during the quarter, we are confident that we resolved this issue and we do not expect any further disruptions of this nature.

Furthermore, we also commenced operations at our Stateline 10 compressor station, providing us another 90 million cubic feet of throughput and even more flexibility in the region going forward. Turning to slide 16. As I look ahead to the remainder of the year, our Delaware asset is well positioned to build upon the solid results we achieved in the first quarter. Overall, with the 200 wells that we plan to bring online this year in the Delaware, we expect well productivity to be very consistent with the high-quality wells we brought online over the past few years. And for context, as shown on the chart to the right, this level of well productivity would not only position Devon among the top operators in this world-class basin, but would also surpass the performance of other top shale plays in the US by a noteworthy margin.

This impressive well performance, coupled with a long runway, a high-value inventory, further underscores the competitive advantage and the sustainability of our resource base in the Delaware Basin. Turning to slide 17. Another asset, I’d like to spend some time on today is the Eagle Ford, which is our second-highest funded asset in 2023. Over the past few years, we’ve taken the disciplined and scientific approach to refine the next phase of development in this prolific field through thoughtful and measured appraisal work. The momentum generated from these learning’s is evident in our current capital program, where we are pursuing tighter infill spacing and have active refrac program, with the goal to efficiently sustain a steady production profile and harvest significant free cash flow.

This year, we plan to spud over 90 wells, with the majority of this drilling focused on redeveloping acreage with much tighter spacing than originally conceived when we first entered the play a decade ago. We attributed this infield opportunity to high reservoir pressure, a fractured network that heals quickly and low but consistent permeability. This unique combination allows us to pursue significantly tighter spacing, with redevelopment activity targeting 16 to 20 wells per unit across multiple landing zones in the Eagle Ford. In addition to the benefit of oil-weighted recoveries that are projected to exceed 0.5 million barrels per well, our ability to leverage this existing infrastructure in the play also bolsters the returns. These unique and favorable reservoir characteristics in the Eagle Ford provides us with many years of highly competitive drilling inventory.

The team has also made steady progress on our refrac program in the Eagle Ford, achieving consistent, successful and restimulating the productivity of older wells. To date, we have roughly 30 refracs online that have successfully accessed untapped resource, resulting in an immediate uplift to the well productivity that has expanded per well reserves by more than 50%. In 2023, we plan to execute around 10 refracs and we’ve identified several hundred high-return candidates across the field to pursue in the future. While we have made significant progress on improving recoveries through infill spacing and refracs, we believe there’s still meaningful resource upside in this play. A catalyst to help us accelerate our learning’s in this area is our Zgabay pilot in DeWitt County, which is supported by a grant from the US Department of Energy.

The objective of this grant is to fund as field study and create an underground laboratory to improve the effectiveness of shale recoveries by testing new monitoring techniques for both initial stimulation and production as well as collecting critical data to enhance recoveries via refracking and EOR. While we’re still in the early stages of gathering and interpreting the data from this project, we have already incorporated learnings into our day-to-day operations. These learnings will enable us to optimize recovery of resources, not only in the Eagle Ford, but across our broader footprint in the US I expect to have more positive updates on this topic in the future. And finally, on slide 18, I’m also excited to talk about the positive results we’re seeing delivered on other key assets across our portfolio.

As you can see on the graphic to the right, over the past year, we’ve done some good work to opportunistically build up operating scale in these areas and increase the production by 9%. The main factors that drove this growth were our Dow JV partnership, which helped us regain operational momentum in the Anadarko Basin, the RimRock acquisition in the Williston and the quality assessment work we’ve done in the Niobrara oil play in the Powder River Basin. That has helped us build for the future. In addition to solid production growth, this diversified group of assets is on pace to generate a meaningful tranche of cash flow that we can deploy to other key strategic priorities such as the return of capital to shareholders. I appreciate the team’s hard work and the effort that goes into delivering near-term free cash flow and also derisking valuable future inventory.

With that, I’ll turn the call over to Jeff for a financial review. Jeff?

Jeff Ritenour: Thanks, Clay. I’ll spend my time today covering the key drivers of our first quarter financial results, and I’ll also provide some insights into our outlook for the rest of the year. Beginning with production, our total volumes in the first quarter averaged 641,000 BOE per day. This performance exceeded the midpoint of our guidance for the quarter due to better-than-forecasted well performance across our asset portfolio. Looking ahead, our second quarter completion activity is weighted towards the back half of the period. As a result, we expect volumes to be relatively flat in the second quarter as compared to the first. However, given the cadence of activity, we do expect to build momentum throughout the second quarter, setting up the third quarter to be the highest production quarter for the year.

On the capital front, we invested $988 million in the first quarter, which was in line with expectations. Looking ahead to the second quarter, we expect capital spending to remain essentially flat versus the prior period. As a reminder, we do expect to spend more capital in the first half of the year given the timing of completions in the Delaware Basin. This higher level investment in the first half of 2023 sets up Devon for a stronger production profile in the second half of the year. Moving to expenses. We did a good job controlling costs in the quarter with several of our expense categories coming in better than forecast. Looking ahead, as Rick touched on earlier, we’re seeing cost pressures plateauing across our business, and with a solid start to the year, we feel very comfortable with our full year guidance ranges for operating cost and corporate expense.

Jumping to income tax. After adjusting for non-recurring items, cash taxes were 11% during the first quarter. This better-than-expected result was driven by an R&D tax credit that was taken in the quarter. Looking ahead, we expect our cash tax rate to step up to around 15% for the remainder of the year. Cutting to the bottom-line, Devon’s core earnings totaled $952 million or $1.46 per share. This level of earnings translated into operating cash flow of $1.7 billion. After funding our disciplined maintenance capital program, we generated $665 million of free cash flow in the quarter. With this free cash flow, our top priority was to accelerate the return of capital to shareholders. As we communicated in the past, the first call on our excess cash is the funding of our fixed plus variable dividend.

Based on our strong first quarter financial performance, we declared a dividend of $0.72 per share. This distribution will be paid at the end of June and once again includes an $0.11 per share benefit from the divestiture contingency payments received earlier in the quarter. Another highlight for the quarter was the continued execution of our ongoing share repurchase program. We remain confident in the intrinsic value of our equity as evidenced by the repurchase of $692 million of our stock so far in 2023. With the Board expanding our share repurchase program to $3 billion, which is equivalent to 9% of our outstanding share count, we have plenty of runway to compound per share growth as we work our way through the year. Moving to the balance sheet.

We exited the quarter with $3.9 billion of liquidity, consisting of $887 million of cash on hand and $3 billion of undrawn capacity on our unsecured credit facility. With this strong liquidity, Devon exited the quarter with a low net-to-debt EBITDA ratio of 0.6 times, well below our mid-cycle leverage target of one times or less. Looking ahead, we plan to further improve our balance sheet by retiring additional debt as maturities come due. Our next debt maturity comes due in August of this year, totaling $242 million. We’ll have additional opportunities to pare down our debt with maturities coming due in 2024 and 2025 as well. As I look ahead, I’m confident that our financial framework provides us the necessary flexibility to effectively manage through the unpredictable fluctuations of commodity prices, while optimizing value creation for our shareholders.

With the business plan designed to generate substantial amounts of free cash flow, we’ll look to grow our fixed dividend over time, pay out as much as 50% of our excess cash flow via a variable dividend, opportunistically buy back shares and take additional steps to improve our financial strength. Furthermore, we possess the flexibility within this framework to lean in to any one of these options to maximize result for shareholders. We believe this balanced and transparent approach is differentiated versus peers. With that, I’ll now turn the call back to Rick for some closing comments.

Rick Muncrief: Thank you, Jeff. Great job. I’d like to close today by reiterating a few key messages. Number one, our team did a superb job of meeting the operational targets we set out for ourselves in the first quarter through solid well productivity and effective cost management. Number two, our disciplined execution resulted in another strong financial performance for the company. This is evidenced by the attractive per share growth we’re delivering, substantial cash returns realized by investors and the high returns seen on invested capital. Number three, with a solid start to the year, we’re now on track to achieve all of our capital objectives in 2023. Inflation is showing signs of plateauing and our business is well positioned to build momentum and generate substantial free cash flow as we progress through the year.

Number four, and lastly, we have the resource depth, execution capabilities, financial strength and disciplined business model to continue to deliver sustainable results through the cycle where a premier energy company are also perfectly positioned to benefit from this multiyear upcycle. And with that, I’ll now turn the call back over to Scott for Q&A.

Scott Coody: Thanks, Rick. We’ll now open the call to Q&A. Please limit yourself to one question and a follow-up. This allows us to get to more of your questions today on the call. With that, operator, we’ll take our first question.

Q&A Session

Operator: Thank you. Our first question comes from Neil Mehta from Goldman Sachs. Neil, please go ahead.

Operator: Thank you. Our next question comes from Arun Jayaram from JPMorgan. Arun, please go ahead.

Operator: Thank you. Our next question comes from Neal Dingmann from Truist. Neal, please go ahead.

Operator: Thank you. Our next question comes from John Freeman from Raymond James. John, please go ahead.

Operator: Thank you. Our next question comes from David Deckelbaum from Cowen. David, please go ahead.

Operator: Thank you. The next question comes from Matthew Portillo from TPH. Matthew, please go ahead.

Operator: Thank you. Our next question comes from Scott Hanold from RBC. Scott, please go ahead.

Operator: Thank you. Our next question comes from Doug Leggate from Bank of America. Doug, please go ahead.

Operator: Thank you. Our next question comes from Paul Cheng from Scotiabank. Paul, please go ahead.

Operator: Thank you. Our next question comes from Roger Read from Wells Fargo. Roger, please go ahead.

Scott Coody: Well, it looks like we’re at the end of our time slot for today. We appreciate everyone’s interest in Devon, and if you have any further questions, please don’t hesitate to reach out to the Investor Relations team at any time. Have a good day.

Operator: This concludes today’s call. Thank you, everyone, for joining us today. You may now disconnect your lines.