Fall Picks & Pans for IG and HY Energy

• We are refreshing our Energy picks and pans across both IG and HY.
• Within IG, we are upgrading DVN to Outperform from Market perform and maintaining our Outperform recommendations for WES, APA, EQT and EPD hybrids. We continue to expect WMB, EOG and EPD sr unsecured notes to Underperform the peer group.
• Among our HY coverage, we are upgrading VTLE to Outperform from Underperform and EQM to Outperform from Market perform, while maintaining an Outperform on PEMEX and an Underperform on RRC.

Financial Metrics

Pick – Upgrading Devon (DVN: Baa2/BBB/BBB+) to Outperform

We are upgrading DVN to Outperform after the recently issued 2034 notes have sold off to +135 and offer spreads in-line with low-BBB issuers. A lingering concern is that we think DVN could return to the M&A market to bolster its Delaware acreage, but this may not be a credit negative if funded in a prudent manner as most Energy M&A has been. We also consider it less likely to occur prior to incremental debt paydown.

While DVN used a mix of cash ($1 bn) and new debt to fund $3.25 bn of its recently completed $5 bn acquisition of Grayson Mill, leverage will remain at just 0.9x pro forma for the deal. Additionally, Midstream assets that could be worth ~$1bn were included inthe acquisition and CEQP’s (acquired by ET in 2023) former management said they would integrate well into their assets. In addition to maintaining strong metrics, DVN’s capital allocation policy provides flexibility in the event commodity prices disappoint next year. After funding the fixed annual dividend of ~$570 mn, up to 70% of the excess free cash  flow each quarter will be distributed to shareholders through the variable dividend and the majority of remaining cash flow will be used for buybacks. The remaining ~30% will go to the balance sheet to execute on the $2.5 bn debt reduction program.