Devon drilling rigs and derricks in Oklahoma City in 2017.
Zeytun Images/Dreamstime.comFor investors who think the oil price rebound is here to stay and who want to invest in a shale-drilling rebound, Devon Energy offers a unique and potentially lucrative payoff.
Its recently closed acquisition of fellow producer WPX Energy gives the Oklahoma City producer scale, and should allow it to return more capital to shareholders, analysts say. Devon (ticker: DVN) is no slam dunk — it has holdings on federal land that could be affected by Biden administration policies — but it also has an innovative dividend policy that has been attracting some investors.
Devon and WPX closed their “merger of equals” on Jan. 7, and the company’s market cap is now over $12 billion, after Devon’s value had fallen below $5 billion for much of 2020. Analysts at J.P. Morgan and Citigroup reinstated coverage on the stock with Buy ratings on Tuesday after the deal closure. Devon shares were down 0.3% on Tuesday morning ,to $18.69.
Devon’s dividend yield is 2.4%, but it’s planning to institute a new dividend policy this year that will add a variable dividend to its fixed payout. That will give the company flexibility to pay money to shareholders when times are good, while keeping it from having to lower the fixed dividend when times are tough.
“Given Devon’s healthy balance sheet and $1.5 billion debt reduction goal by year-end, we see the company as ahead of the curve on returning free cash flow to shareholders,” Citi analyst Brian Downey wrote.
The variable portion of the dividend could be a huge benefit. J.P. Morgan analyst Arun Jayaram estimates that if West Texas Intermediate crude prices rise to $60 a barrel (they’re now at $58), Devon could return $1.80 per share this year, for a yield of nearly 10% at the current stock price.
That said, the risks to Devon are worth considering, too. About 35% of Devon’s acreage in the Delaware Basin in West Texas and southern New Mexico — a major part of its holdings — is on federal land, and the company could face new restrictions based on Biden administration policies. Devon has underperformed in recent weeks, likely because of that exposure.
In addition, the bull case on the stock is heavily dependent on oil prices staying strong. Downey’s price target is $24, implying a nearly 30% gain from here. But that’s based on a West Texas Intermediate oil price of $55 a barrel, which is just under current futures prices.
Oil prices have increased much faster than most fundamental analysts had expected, and some now think they’re entering bubble territory. A slowdown in the economy or a policy change by OPEC could quickly send prices south. If prices fall back to the mid to low-$40s, Downey expects Devon shares could fall 25%.
Jayaram’s dividend estimates change sharply depending on oil prices. At $45 oil, for instance, Devon could return 97 cents this year, or closer to a 5% yield. At $40, the payout falls to 68 cents, to a 3.7% yield.
Write to Avi Salzman at avi.salzman@barrons.com.
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Devon Energy's Dividend Could Pay Off Big - Barron's
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