Keeping Its Energy Close to Home

01/25/2010 1:00 pm EST

Focus: STOCKS

James Stack

President, Stack Financial Management

Jim Stack, president of Stack Financial Management and editor of InvesTech Research, likes an exploration and production company that’s focusing on North America.

For the most part, traditional bull market sectors continue to lead the [Standard & Poor’s] 500 index, while the defensive sectors are lagging. Among the notable changes, financials have sunk to the bottom of the list as speculative momentum dissipates. Technology has risen to the number two slot, which is more consistent with past bull markets.

Meanwhile, recent strength in health care and energy stocks has moved these groups up among the leaders. In fact, the current leadership ranking is an indication that investors are feeling more comfortable about the economy and are refocusing their attention on fundamental value.

Devon Energy (NYSE: DVN) is refocusing itself. Non-core holdings are being shed, and the proceeds are being used to accelerate growth of the company’s premier North American assets.

We stepped up our allocation to the stock in November, when the restructuring was announced. Yet, even after recent gains, Devon continues to look attractive as the full effects of the transition are still materializing.

Devon grew up as a company in the natural gas shale plays of the Midwest. Through superior technology, a focus on cost discipline, and a consistent track record, Devon has become one of the largest independent exploration and production companies in the United States. As the firm has grown, so, too, has its asset base—encompassing emerging natural gas fields all over the world.

In an all-too-often rare move, Devon’s management has realized that the company currently has an overabundance of opportunities. To better position itself, Devon has decided to compete where it is most competitive—North America. As a result, all of the firm’s international and Gulf of Mexico production fields will be sold.

As Devon narrows its focus to North America, the fundamentals of the firm continue to improve. Over the last three years, Devon has been able to grow North American production at 9% per year, while international production has stagnated.

Besides allowing Devon to refocus on its most profitable fields, the asset sales are expected to raise $4.5 billion to $7.5 billion in cash. With these funds, management plans to take the very positive approach of: 1. paying down debt to strengthen the company’s already healthy balance sheet, and 2. ramping up production to further leverage the growth potential of the firm’s existing domestic acreage.

As the fundamental prospects for Devon continue to improve, its valuation remains attractive. In fact, compared to what Exxon Mobil (NYSE: XOM) recently agreed to pay for XTO Energy (NYSE: XTO)—one of Devon’s main competitors—this stock looks downright cheap. With a more focused outlook, a strengthening balance sheet, and great valuation, we continue to view Devon as an untapped opportunity with years of growth ahead. (It closed slightly above $69 Friday—Editor.)

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