Devon Energy Corporation (DVN) Earnings Call Transcript & Summary

That's part of it. Thinking about how do we leverage technology, how do we use the genius human beings in conjunction with the technology to lower base declines, improve recovery factors, ultimately manifesting in better production. And then the byproduct -- I'm sorry, I get really excited about this. The byproduct of improving that base decline and improving that uptime is that now assuming that we hold the line on this maintenance capital, so we're kind of a mid-380s oil-producing company, let's say we just continue to run that forward. Now the maintenance capital required, the number of sticks, the amount of that precious inventory that we consume every year gets a little bit lighter lift each year, okay? So think of the business optimization is also an inventory enhancer.

Absolutely. It's a virtuous cycle. All right. I can dig out on this a lot more, but back to the free cash flow trajectory. So the maintenance CapEx actually feeds into this question. Like how to think about the business free cash flow generative ability beyond this year? Because you have the cost tailwind, you got the tax tailwind, you've got the...

Maturing of the portfolio...

Yes. maturing of the portfolio where it gets less capital intensive. So how do you see that free cash flow wedge expanding?

Yes. That's the challenge we fight every day, right? We're always trying to drill our best wells first. Inevitably, we are chewing through some really good inventory. And inevitably, like everyone else, we have a creamy curve that we go through. So how does technology, how does our efficiency offset that natural maturing of that portfolio. What I would tell you is when you look back in the last few years, '22, '23, '24, '25, you'll see a little bit higher average well productivity, a little bit lower. But inside those high and low watermarks is kind of a reasonable expectation of what we think our productive capacity is from our existing inventory as we fast forward out 3, 5 years kind of into the visible future. Now 5 years from now, we're going to be a whole lot smarter and we'll be a whole lot better and a lot more efficient. And I'll reserve judgment on years 6, 7 and 8 just yet. But I would say for the foreseeable future, we think we're in that productivity bandwidth, okay? When you think about the capital efficiencies, you think about the technology evolution, I'm pretty optimistic on a growing free cash flow. We're in a ballpark of about $3 billion this year. I think that can continue to expand in the next coming years. Certainly, that is the line of sight, the focus that we have with this business optimization. That is the North Star. So you need to hold us accountable to growing. Now of course, that takes into account a presumption of a mid-cycle commodity price environment. I mean, oil price certainly is the biggest input on free cash flow. We run about a $65 mid-cycle, and that's plus or minus about where we've been amazingly consistently, by the way, even with the call for too much oil -- OPEC oil coming online and all that. I think we haven't been too terribly surprised that gas hasn't run away. And I don't think we've been too terribly surprised that gas -- that oil hasn't fallen back. We're about a $350, $65 shop running for the next few years. And hopefully, as the oil production comes back online, continues to come in online. We'll have to watch China demand. We certainly watch all the macro signals, but we don't see a significant indication of things running away one way or another.

That makes sense. And then look, that's because the business looks really good in...

It works exceptionally well. Yes, we're generating -- I mean if you think of our 53- or 4-year history, I mean, generating $3 billion in free cash flow is an outstanding top 5 year in our 50-year history. And I think people look at the business today is like, oh, I just don't think things are going too well, like -- I don't know what planet you're living on. This is a hard business. And I've been in it long enough to know that these are the good years. We need to celebrate these years, and we need to propagate more and more years exactly like this, generating this amount of free cash flow, buying back shares, paying down debt, stockpiling cash onto the balance sheet, that's winning guys. That's exactly what we're trying to do.

So double-click on that last comment about use of that free cash flow. So you're halfway through the $2.5 billion debt reduction target, but that reduction is a big focus now. But by the time you get there, how do you think about cash return? And you mentioned just now stockpiling cash on the balance sheet, which also naturally leads to the question of why [stockpiling] cash. So what's the use of that cash?

Yes. So again, I'll start with our base dividend and continuing to grow that every year is kind of a hallmark that we really hope to remain kind of foreseeable future. So that's essentially a nonnegotiable as we start there. Above and beyond that, we've been buying back between $200 million and $300 million worth of our stock each quarter. As we get more free cash flow, certainly, half of the audience, I think you might be on this side of the equation, would like for us to lean in a little bit more on the share buybacks. And I can tell you that we'll continue to revisit that. But as a starting assumption, consider that $200 million to $300 million kind of the right relative frame. What we will try to avoid doing, which I've seen our industry do and other industries do, especially in commodity businesses where say, for example, oil price runs, you get a lot of free cash flow. It's very tempting to buy back shares there exactly when you shouldn't buy back shares because that's when your shares are typically highest valued in the cycle. And then the contrary is true on the flip side. By having a little bit more of a methodical quarter-to-quarter basis, we feel like that helps take those dollars when you're traded a little bit lower and leverage them into more shares. And then on the countercyclical side, you're buying fewer shares when your prices are -- when your share price is higher on a per share basis. So that's kind of a rough generic view going forward. Certainly, you mentioned the debt paydown, $2.5 billion. We're well on our way. I feel very confident about being able to knock down the $500 million that's coming callable. And then we have a $1 billion term loan, we'll be able to take those out. I feel very confident in being able to do that. I think above and beyond that, hey, let's get the wins on the scorecard. We'll post more wins in the quarter. When we have more credibility that we received associated with this $1 billion. And by the way, I don't expect us to be done in $1 billion. I expect that momentum to carry us through. I think there will be more and more wins on the technology front that we'll be able to lever to the bottom line. And then we'll talk about what do we do with those proceeds. As far as the balance sheet and bringing dollars onto the balance sheet for now, I think the best way for us to pay down debt is in a net debt sense. And so starting with the callable debt, we'll be able to take that down. This term loan, we'll be able to take that down. Above and beyond that, we don't have a lot of callable debt. And so the most cost-effective way we can do that is just offset that with cash. There's a very little carrying cost associated with that debt. But certainly, as it becomes due, we'll be able to continue to chip down at that.

Great. That makes sense. Along the line with the -- talked a lot about upstream. Just how do you think about the value creation enabled by midstream and then the investment in the midstream business? Because you guys have been pretty early in doing the partnership with WaterBridge. Just what's your philosophy around that?

Yes, I think this goes deep into our DNA. I mean you've seen Devon over lots of years, do things in the midstream space, very confident in this space. This is a skill set that we have, and a lot of times, we can lever our upstream skills into more lucrative midstream deals. There's many, many, many examples of this. One of the most recent is the WaterBridge -- or excuse me, the Matterhorn deal. And so we held an upstream position that enabled us -- really required us to help underwrite that pipe. great team we worked with quite a bit. We made a 5x multiple on that investment. But more important to that, we had the governance and the position and the relationship with that team to make sure that, that pipe was built because the most important thing for us was getting that additional capacity of gas out of the Delaware Basin all the way to the Gulf Coast. And so we were able to accomplish that. And then you saw us at the same time, we announced the sale of Matterhorn. Again, we capitalized on an investment, but most importantly, we accomplished our bigger goal, which is getting the pipe built, okay? The same time, you saw us announce something that seemed to move the opposite direction, where we bought out the second half of the interest of the Cotton Draw midstream. So this is a deal that we had in the works for several years. Our partnership there, we needed to build out some infrastructure. We didn't want to put it entirely on our capital burden. So we had a partner come along. We've taken that partner out now. We own that. And this -- again, this will be about $50 million to $90 million per year of avoiding cash out the door paying our partner. This is a very significant return on investment associated with this $260 million investment. And by the way, very importantly, those are 2 examples of deals that we're not claiming credit on towards our business optimization. This again, you mentioned early, we didn't expect to get 100% credit associated with that on the day of announcement. More quarters come, the more earnings that we post towards this goal, we will get more and more credit in the market associated with that. But I think credibility associated with not claiming kind of easy victories, you mentioned the tax bill. That's about $300 million a year benefit to us. That is a $300 million benefit in free cash flow. We're not claiming credit on that. That's not part of our $1 billion optimization. We're seeing a little bit of deflation. I'd characterize it as an overall deflationary market. Those savings, we're trying to parse out set aside. All 4 of those things are above and beyond our $1 billion target, and we're trying to be as consistent and credible on this $1 billion as we possibly can because I think the most important value creation opportunity for our Devon shareholders is increasing this credibility, increasing this view of this team's ability to create more and more value with these assets. And then I think that opens up many more doors down the lines on more interesting things to do.

Yes. No, that makes sense. And if we just click back on the water side of things, it's -- you recently signed an agreement to buy pore space. I guess, where do you see other opportunity when it comes to the midstream infrastructure? Do you see that as an area of investment for Devon or see that as an area of monetization down the road around the partnership?

Yes. I don't see this particular -- the deals that we're doing around water as significant business extensions of what we do. This is a little bit more business enablers. And so I think about working in the Delaware Basin, 2 of the most critical things that you need to be really good at is, one, getting electricity to location; and two, is getting water away from location. And those don't get any headlines and they don't get any excitement. But I can tell you, if you fail at either of those, you're not getting oil away from the asset either. And so they're fundamental enablers. And when I think about the work that we've done on both of those fronts over multiple years, I think we are well ahead of many of our peers, and I'm really proud of the work that we're doing. Today, in state-of-the-art New Mexico, there are no more electricity coming -- there's no more electricity that we can source from the utilities. [indiscernible] said, look, we're tapped out. We can't build anymore, whole political thing, I'll have a beer with -- we'll share some, commenting on some of those issues. But self-induced issues in New Mexico. There is no more electricity available. And so what have we done? We've been very proactive over the last several years. We built over 800 miles of electrical distribution. We've got our own microgrids. In addition to generators on location, we're now looking at our own infrastructure. Step beyond that, we'll be looking and trying to understand our capabilities of building co-ops with peers to build our own -- essentially our own utilities. That's a whole political challenge and a whole another step. But that's kind of the future that we're having to explore in a defensive mechanism. Water, as you mentioned, it's another absolute critical path item to make sure that we have the ability to do what we do. We produce just ourselves about 1.5 million barrels of water per day, okay? That is a tremendous amount -- every single day, tremendous amount of water. A lot of that goes from New Mexico to Texas, and we own a lot of that infrastructure. You go back to the WPX legacy all the way back to 2015, one of the enablers of us entering the basin was that RKI had put a lot of water infrastructure and wells and pipes in place. That enabled us to really be able to see the value creation opportunity. We have built so much more since then. And then as you mentioned, we've done JVs. WaterBridge is the latest one. They had bought a bunch of open land, big 20,000-, 30,000-acre ranches that hadn't been drilled yet. And so this is virgin acreage that hasn't been -- the pore space hasn't been tapped. What was notable in one of our recent announcements is that we reserved actual pore space. It does not matter if you have pipe or even if you have wells. If that pore space is full, you're done. And so thinking really holistically about those potential gating issues and for Devon, really being proactive about making sure that we have the ability to continue to produce this incredible resource for decades to come.

That's great. Well, as a wrap-up, I was going to ask you what makes -- what parts of Devon are you most excited about? Everything we talked about, you're really excited about. So is the takeaway -- the free cash flow, the North Star, when you think about how you -- the one thing that you look at to look at the progression of the company, is this the free cash flow expansion?

Look, at the end of the day, we're here for shareholders. And so how do we create more value for shareholders? I think the key enabler is unlocking this credibility and this incremental value creation. And so I say credibility because we all think also in trading multiples. Right now, I think we're a bargain entry price. I think as we post more scores on the board in the coming quarters, we'll continue to unlock that potential. I think that's the investment thesis for Devon. Now what we do with that credibility is equally important. And so what you'll see us talking more and more about is more out on the horizon value creation opportunities, which is a whole another 30 minutes we'll have some other time.

Well, it's been a fun conversation, Clay. Thank you so much.

Appreciate it. Absolutely.