Devon Energy: Learn To Love The Variable Dividend (NYSE:DVN)

Energy prices are slumping as U.S. domestic production continues to surge. Devon Energy (NYSE:DVN) has been one of the favored energy picks due to the more reasonable valuation in the sector and investors possibly shying away from the variable dividend. My investment thesis is ultra Bullish on the independent energy giant left out of the recent deals in the energy sector.

Depressed Energy Prices

Devon reported a solid Q3, but energy prices have slumped since the quarter ended in September. While most people have noticed the oil price dip, natural gas prices are back closer to yearly lows.

Domestic natural gas production continues to soar with 105 bcf/d production for November far above the 2022 levels. The five-year average is down at 95 bcf/d.

The end result is depressed energy prices that will contribute to weak Q4 results and start 2024 off slow for domestic energy companies. Devon reported a strong bounce back in Q3’23 with an EPS of $1.65, up sequentially from $1.18 and at near yearly highs.

The problem is that Devon reported the following realized energy prices during the quarter:

• Oil – $82.06
• Natural Gas – $2.54
• NGL – $26.62

All of the energy prices are lower now in mid-December. The big key is that oil prices are barely holding above $70/bbl now and natural gas has so much production the market is lucky prices are mostly flat now from the average realized prices for Q3.

The consensus analyst estimates generally forecast Devon earning $1.55 to $1.60 a share on a quarterly basis over the next year. Energy prices generally aren’t this consistent for a 12-month period, so investors will need to accept volatile prices.

Recent Deals

All of the recent deals are very supportive of owning Devon at the current valuation. Assuming the energy company can create a $6+ EPS going forward, the stock only trades at about 7x EPS targets.

Both Hess Corporation (HES) and initiate Natural Resources (PXD) were recently acquired at much higher valuations. Naturally, energy companies can’t be valued solely on earnings with resources and such offering value beyond just current production levels.

Regardless, Devon Energy is incredibly cheap at this valuation. The company could even face a period of lower profits, considering energy prices are slumping, and still be cheap in comparison to the deal multiples for Hess and initiate.

Devon has a strong dividend to reward shareholders to expect for the stock to trade at a more rational value. Devon declared a $0.77 fixed-plus-variable quarterly dividend following the strong Q3 to boost the dividend yield to 6.9%.

A good possibility with the current valuation disconnect is that the market doesn’t admire the fixed dividend payout of only $0.20 each quarter. Investors should learn to accept dividend payouts based on actual income to keep the balance sheet healthy. While the quarterly dividend did dip to only $0.49 for the Q3 payout, Devon has regularly paid out vastly more amounts each quarter due to higher income.

On top of this large dividend, Devon regularly repurchases shares. The company has spent $2.1 billion on share buybacks since the WPX Energy merger, including $745 million in Q3.

Even with WTI prices at $70/bbl, Devon has a higher free cash flow yield than the stock market as a while. The FCF yield would dip to 8%, but the S&P 500 is at only 5% while higher WTI prices will furnish far higher FCF yields.

The opportunity is buy Devon down at the multi-year lows due to depressed energy prices. Oil could easily dip into the $60s here, but at some point in the future oil will again bounce back above $80/bbl and the stock should trade appreciably higher while investors have also collected sizable dividends in the process.

Takeaway

The key investor takeaway is that Devon Energy trades at a depressed stock price despite several major deals in the energy sector. The stock is likely cheap due to a market not preferring the variable dividend, but investors should accept the cheap stock knowing the payouts are large and could rise.

Investors should use the stock at multi-year lows as an opportunity to load up and premier energy company.