Devon Energy Corporation (NYSE:DVN) Q3 2023 Earnings Call Transcript

Devon Energy Corporation (NYSE:DVN) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Hello, everyone, and welcome to Devon Energy Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. This call is being recorded. I would now like to turn the call over to Mr. Scott Coody, Vice President of Investor Relations. Sir, you may begin.

Scott Coody: Good morning, and thank you for joining us on the call today. Last night, we issued an earnings release and presentation that cover our results for the quarter and updated outlook. 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 U.S. 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 the time to join us. For today, I plan to focus my comments on the trajectory of our business for the remainder of 2023 and highlight the steps we’re taking to further improve capital efficiency as we head into 2024. Now let’s start with a brief review of our financial and operating performance. In the third quarter, Devon delivered a production per share growth rate of 10% year-over-year. This strong growth rate was fueled by our franchise asset in the Delaware Basin, accretive acquisitions and an opportunistic share repurchases over the past year. On a barrel of oil equivalent basis, our total volumes were within the guidance range, but oil volumes were slightly softer due to select well performance in the Williston coupled with minor infrastructure constraints in the Delaware.

We will cover the Delaware in greater detail later in the call, but these constraints were temporary and have a visible pathway to correction with the industry’s ongoing build-out of infrastructure. Turning to capital for the quarter. With our disciplined plan, we’ve kept reinvestment rates to just over 50% of cash flow. This resulted in our free cash flow more than doubling versus the second quarter, and we rewarded shareholders with a 57% increase to our dividend payout. In the fourth quarter, we expect Devon’s production to be around 650,000 Boe per day of which oil is expected to approximate 315,000 barrels per day. Now as a reminder, we dropped our fourth frac crew in the Delaware midyear to replenish our DUC inventory and the impact of this lower completion activity will lead to a minor decline in our production versus the third quarter.

We’ve also modeled in the effects of project timing and weather impacts, some of which we’ve already experienced. However, we do expect our financial performance in the fourth quarter to be very strong with operating margins set to expand and free cash flow to be quite robust. Overall, the fourth quarter is set up to round out another successful year financially for our company. And while we have certainly faced some challenges this year, we’re on track to deliver one of the best years in our 50-plus year history in terms of returns and free cash flow generation. Importantly, as we head into 2024, our focus remains the same. We intend to deliver growth on a per share basis and maximize free cash flow generation, while balancing the need to appropriately reinvest in our business for the future.

To achieve these objectives, we have incorporated our learnings over the past year, pushed service costs lower and sharpen our capital allocation to deliver a step-change improvement in well productivity and efficiency. Now on Slide 8, we outlined the key attributes underpinning our improved outlook for 2024. First and foremost, with continued volatility in commodity pricing, we believe it is prudent to conduct – construct a capital plan with consistent activity levels to maintain production at a level around 650,000 Boe per day with oil at approximately 315,000 barrels per day. With ongoing macro uncertainty and with the ample spare capacity that OPEC+ possesses, we have no intention of adding incremental barrels into the market at this point in time.

This disciplined approach reflects our commitment to pursuing value over volume and shareholders will benefit from our high-graded slate of development projects designed to enhance capital efficiency and returns on capital employed. To deliver this production profile in 2024, we anticipate a capital investment of $3.3 billion to $3.6 billion. This level of spending represents an improvement of 10% compared to 2023, and we expect to fund this program at pricing levels below $40 per barrel. In summary, we see delivering flat production for 10% less CapEx. Now turning to Slide 9. Our improved capital efficiency in 2024 is driven by concentrating more than 60% of our spending in the Delaware Basin. Our plan will shift a higher mix of activity to multizone Wolfcamp developments in New Mexico, which is the core of the play as infrastructure constraints have eased over the past and will continue over the coming months.

We also plan to high-grade capital activity across other key assets in our portfolio. This includes limiting Williston Basin activity to only our highest impact opportunities and decreasing activity – appraisal activity in the Eagle Ford. With this refined capital allocation, we expect to improve well productivity by 5% to 10% in 2024, anchored by our franchise asset in the Delaware Basin. And lastly, we expect our capital efficiency to also benefit from improved service costs as contracts refresh over the next few quarters. Now with this operating plan in 2024, we are positioned to deliver free cash flow growth of around 20% in 2024 at $80 WTI pricing. As you can see on Slide 11, with this strong outlook that translates into a uniquely attractive free cash flow yield of 11%, which is up to 3x higher than what the broader equity markets can offer.

Simply put, this is one of the most critical aspects of the Devon plan. On Slide 12, with the stream of free cash flow, as we’ve done in the past, we plan to target a cash return payout of around 70%, which is in line with our average annual payout to shareholders since we unveiled this industry-first model in 2020. A key priority heading into next year is to continue to grow our fixed dividend. We believe the certainty that comes with a fixed dividend is valued by shareholders and is better capitalized within our equity price, especially if the yield is competitive with that of the broader markets. With the remainder of our free cash flow, we will stay flexible as we always have been by judiciously allocating toward the best opportunities, whether that be increased stock buybacks, variable dividends or taking additional steps to improve our balance sheet.

However, given our current stock price, we expect to pursue buybacks at a level that will most likely result in our variable payout being below the 50% threshold in the near term to capture the incredible value our equity offers at these trading levels. And with that, I’ll now turn the call over to Clay for a rundown of our recent operational performance.

Clay Gaspar: Thank you, Rick and good morning, everyone. For today, I plan to focus my comments on our Delaware Basin operations as well as outlining the actions we plan to take to sharpen our capital allocation and drive efficiencies in our business over the next year. Let’s begin on Slide 15 with an overview of our Delaware Basin activity, which accounts for roughly 60% of our capital spending for this year. With this level of investment during the quarter, we ran a consistent program of 16 rigs and brought on 59 new wells. Well productivity was very strong with 30-day rates averaging 3,000 Boe per day and improved average productivity combined with the benefits of elevated completion activity in the first half of the year drove another quarter of production growth from our franchise asset.

That said, our growth rate in the quarter was held back by a few wind and lightning storms that impacted power for our facilities as well as our third-party infrastructure. These storms stranded a few thousand barrels per day during the quarter. The infrastructure and the wells are back online, and we don’t see any negative impacts on the ultimate recovery of these wells. On Slide 16, you can see our impressive well productivity in the Delaware Basin during the quarter. It was highlighted by three important projects. On the far left of the slide, Devon’s top result for the quarter was the Bora Bora project. Developing the Upper Wolfcamp at our Todd area, with 30-day rates from Bora Bora, averaging 4,600 Boes per well, with the cost coming in under budget, these returns are expected to be well into the triple digits for this project.

Another noteworthy project was our CBR 17 development in Texas, where 30-day production rates averaged 4,100 Boe per day per well. The CBR 17 results were enabled by a 3,000-acre trade completed about a year ago that I highlighted on the previous call. This key trade, which unlocked our ability to pursue extended reach laterals by extending our laterals to two miles for this project, we added several million dollars of net present value in this project alone. On the right, another key result for us was the Haflinger project, where we co-developed multiple zones in the Wolfcamp A and B. While rates were restricted due to infrastructure, recoveries on this are on track to reach 1.5 million Boe per day per well – excuse me, per well. With solid returns from our Wolfcamp B appraisal today, we now plan on bringing forward of this opportunity by co-developing the Upper Wolfcamp where possible in the future activity.

Looking forward to the project level details, Slide 17 provides a nice visual of the well productivity we achieved in the Delaware Basin during the third quarter. On the left, as I touched on earlier, 30-day average rates for the Delaware wells we brought online reached 3,000 Boe per day. These high-impact wells exhibited a 20%-plus improvement from the first half of 2023, reaching the highest quarterly level in more than a year. This performance is great to see, given our well productivity over the past year has been held back slightly by elevated appraisal requirements and infrastructure constraints. The 2023 infrastructure constraints resulted in a shifting a portion of our capital to less prolific areas in the basin and at times, constrained peak rates across a subset of our new wells.

As you can see on the right-hand side of the slide, we also made progress improving our cycle times across our drilling and completions operations in the basin. Third quarter results were highlighted by our completion space exceeding 2,000 feet per day for the fifth consecutive quarter, and we drilled several pacesetting wells that achieved spud rig release times of less than 15 days. With the momentum we’ve established, we believe we can build upon these results and capture further efficiencies and as we head into 2024. Turning to Slide 18, as Rick touched on earlier, we’re excited about the plan we have in place to drive improved well productivity in the Delaware with our 2024 plan. With the ongoing industry build-out of infrastructure in the form of electrification, compression, localized processing and downstream takeaway, we plan to allocate approximately 70% of our capital to the Delaware Basin and specifically to the core of New Mexico, while we can optimize the remaining activity across our acreage in Texas.

As you can see on the chart on the left, by refining our focus on high-impact Wolfcamp zones in the core of the play with less appraisal requirements, we expect Delaware productivity to improve by 10% in 2024. Looking beyond 2024, we have a long runway of high value inventory in the Delaware that positions Devon to deliver highly competitive results for the foreseeable future. As we’ve discussed in the past, we’ve identified more than a decade of risked inventory across the Delaware and we expect to steadily replenish this inventory over time as we successfully characterized the many upside opportunities across this back play resource. In addition to our internal estimates, there are plenty of third-party services that can provide in-depth evaluation of our resource base.

A great example of this on Slide 19 and that references the recent Enverus Permian inventory report. While I won’t go through all of the details on the slide, there are three key takeaways you should have. First, one of the – we have one of the largest remaining inventories of any operator in the Delaware. Second, the quality of this inventory is excellent with returns exceeding a PV-10 breakeven at $40 WTI. And third, we possess significant upside to our risk resource from many known geological viable zones that have yet to be fully characterized. So in summary, with the Delaware accounting for roughly 60% of Devon’s total risk resource, we’re going to be delivering some excellent results for quite some time. And with that, I’ll turn the call to Jeff for a financial review.

Jeff?

Jeff Ritenour: Thanks, Clay. I’ll spend my time today reviewing our financial performance in the third quarter and discussing our cash return approach for the future. In general, revenues and expenses came in line with expectations for most categories in the third quarter. However, high natural gas price realizations and lower tax rate due to R&D tax credits taken in the quarter drove our earnings beat versus the Wall Street consensus. Putting it all together, operating cash flow totaled $1.7 billion in the third quarter with capital reinvestment rates at 52% of cash flow, generating $843 million of free cash flow and more than twofold increase versus the prior period. With this free cash flow, a key priority for us was to strengthen our financial position.

In August, we paid off $242 million of maturing debt, and we bolstered liquidity with cash balances increasing by 56% to $761 million. With these actions, Devon exited the quarter with a net debt-to-EBITDA ratio of just over 0.5 turn. Moving forward, we plan to add to our financial strength in each quarter by committing around 30% of our free cash flow back to the balance sheet. This will allow us to further pare down our absolute debt balance with repayment of roughly $1 billion of maturities coming due in 2024 and 2025 and maintain a minimum cash balance in excess of $500 million. Cash returns to shareholders increased materially in the third quarter. Based on third quarter results, we declared a fixed plus variable dividend of $0.77 per share, an increase of 57% from the prior quarter.

This dividend payout represents an attractive annualized yield of over 6% at today’s share price. In addition to the dividend, we have a $3 billion share repurchase authorization in place. To-date, we’ve repurchased 400 million shares at a total cost of $2.1 billion. With this program, we are on pace to decrease Devon’s outstanding share count by up to 9%. Although we temporarily paused our repurchase activity in the third quarter, retire debt and – excuse me, and to build cash, we continue to review buyback – or we continue to view buybacks as a critically important tool for us to compound per share growth for investors over time. As Rick stated earlier, we’ll target 70% of free cash flow for cash returns to shareholders moving forward.

With the recent weakness in our share price, investors should expect us to be an aggressive buyer of our equity once we come out of the earnings blackout and the general weighting of cash returns to be balanced towards share repurchases and our growing fixed dividend over the near term. With that, I’ll turn the call back to Rick for some closing comments.

Rick Muncrief: Thank you, Jeff. I would like to close today by reiterating a few key messages from our prepared remarks. Number one, we plan to incorporate our learnings from the past year, tighten a few things up and refine our capital allocation in 2024 to deliver a step-change improvement in capital efficiency. Number two; this improved capital efficiency is anchored by our franchise asset in the Delaware Basin, where we expect well productivity to improve by up to 10% year-over-year. Number three, with our long-duration resource base, we have a depth of inventory to deliver sustainable results through the cycle. And number four, we are deeply committed to a disciplined pursuit of per share value creation and our carefully designed cash term framework that has the flexibility to allocate free cash flow across multiple avenues to optimize shareholder value.

We’ve demonstrated that and we’ll continue to do so in the future. And now 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 will allow us to get to more of your questions on the call today. With that, operator, we’ll take our first question.

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Q&A Session

Operator: Thank you. [Operator Instructions] First question comes from Doug Leggate from Bank of America Merrill Lynch. Doug, your line is now open, please proceed.

Doug Leggate: Thank you. Good morning, everyone, and thanks for having me on. Rick, obviously, the issues in the Bakken and North Dakota are obviously well telegraphed at this point. Your commentary in the slide deck suggests that you’re taking steps to improve productivity. I wonder if you just walk us through what some of those steps are in terms of how the market can get confidence in the results. And at the same time, perhaps you could address your latest thoughts on inventory depth in that asset.

Rick Muncrief: Good question. One of the things that we’ve talked about in improving productivity, really across the company is focusing on capital program as we go into 2024. Obviously, throughout this past year, we’ve done a fair amount of assessment across our resource base and virtually all of our basins. And so I think that what we have learned, we’re going to watch the performance from those wells that we did the assessment on. And then furthermore, as we’ve talked about, really zone in on some of our most productive areas. And so I think while the market may not have fully appreciated the value of assessment work, we know over the long haul that’s how you truly build inventory organically, and it’s very, very helpful for us. So I think that’s the thing that investors need to watch for is we’re going to stay very focused there. Can you repeat the second part of your question?

Doug Leggate: Yes. And just for Mr. Coody, this is not a second question…

Rick Muncrief: Okay. I was expecting it then. Yes, so…

Doug Leggate: Yes, inventory in North Dakota.

Rick Muncrief: Right. Well, I mentioned the – that’s how you can build inventory organically. And I think that that’s the thing I really value about the staff that we have here. We’ve got the depth and the breadth, and we talk about the resource that we have here in-house. And so at times you need to spend a little money assessing some of those resources. That’s what we’ve done in 2023. And so what you’re hearing us say today, we’ve learned some things, we’re tightening some things up, and we’re going to watch some performance, and we’re going to be very, very focused going into 2024. Clay, you have anything, you want to add to that?

Clay Gaspar: Yes. Doug, I’ll just add to that. I appreciate Rick’s comments. And one thing we’ve learned, we’ve been very open on the amount of surprise we’ve had specifically around some of the partially depleted wells that we’ve drilled. We’ve gotten operationally better. We’ve made three or four very specific changes that have improved how we develop those wells, how we bring them online, how we keep them online, small things like artificial lift and even the design of the completion itself. And so as we get better, that improves the productivity, ultimately the economics of those wells in the later life. And so those are learnings that eventually will apply to lots of other basins and feel real confident that given that same circumstance, we now have a better arsenal of tools to approach those wells.

Doug Leggate: Okay. We’ll watch with interest. Thanks for that, Clay. Gosh, I’m torn on what to ask next, but I’m going to go with the variable dividend question. M&A was the other one, Rick, but I’m guessing you wouldn’t answer that. I guess, Jeff, you – sounds like you’re starting to recognize the opportunity to transfer value from debt to equity with your balance sheet comment, but you haven’t ruled out the variable dividend despite the comments around buybacks. Why not just take the variable off the table? Because if I may say so, it seems to me your share price hasn’t had any value recognition for that whatsoever.

Jeff Ritenour: Yes. I appreciate it, Doug. Yes, we understand the bias that the market’s had for share repurchases, and that’s certainly going to be our bias going forward. But we – frankly, we always think the variable dividend can be a component of our framework and expect it to be as we move forward. I appreciate your comments on the balance sheet because again, I’ll just remind folks, as always, that’s our primary priority as we work our way into any year and any budget. We want to make sure we maintain the financial strength. And as you heard in my opening comments, we’re committed to continuing to reduce our absolute debt level. Beyond that, we’re going to grow the fixed dividend as we’ve talked about as well.

We always take that up with our Board in the first quarter of the upcoming year. And as we highlighted it in our materials, we expect to grow the fixed dividend again next year. Beyond that, I think it’s – at least in our view, it’s pretty clear that the equity price is disconnected from the fundamentals of our business. And moving forward here in the near-term, we’re going to lean in on the share repurchases. And as Rick said in his comments, that could have an impact on the variable dividend going forward. But I don’t want to exclude it as an option for us because frankly we think it’s a key component of continuing to deliver cash returns to shareholders. But without doubt our bias is going to be towards the share repo here in the near-term.

Doug Leggate: That’s very clear. Thanks very much, guys.

Rick Muncrief: Thank you, Doug.

Operator: Our next question comes from Nitin Kumar from Mizuho. Nitin, your line is now open. Please go ahead.

Nitin Kumar: Hey, good morning, guys, and thanks for taking my question.

Rick Muncrief: Good morning.

Nitin Kumar: Rick, it’s good to see the refocused energy around the Permian. I want to touch a little bit. You show about 3,000 potential locations in the Delaware in your deck. As you go back to the New Mexico Wolfcamp, the specific area that you’re targeting, can you talk a little bit about how much of that inventory is focused on that area alone?

Rick Muncrief: Yes, a lot of it, to be honest with Nitin is and I think that we’ve actually talked here internally, if you think about our rig count, about two-thirds of our rigs that we have run – are in that area. So that’s a good way to look at it. So two-thirds of that number that you see is pretty accurate, we think. Clay, anything you want to add to that?

Clay Gaspar: Well, as we think about kind of this 70-30 split, it does parallel our inventory. And so we think about most of our inventory being on that north side. Clearly, in 2023, we were very clear, we want to do a little bit more assessment work, spread some of that out. As I mentioned in my prepared remarks, we had to reach in a little bit deeper in some of the areas that we wouldn’t normally have kind of reach into that bolt-in. That kind of diluted a little bit the average productivity that we delivered. I think working through that inventory – or, excuse me, working through that assessment work and really having a better understanding of where that sits. We’re now leveraging those learnings into the activity in 2024 and then also allowing that infrastructure to mature a little bit also allows us to leverage back the benefits of the work we did in 2023 for the benefiting 2024.