Shares of Devon Energy (NYSE: DVN) have rallied nicely in the past few months, despite markets tanking to new lows. Fueling DVN’s gains was its stellar second-quarter results and news that it’s investing in more cash-producing oil assets. Moreover, it also announced a record dividend payout recently, allowing the company to continue its explosive rally, also thanks to higher crude oil prices. Moreover, DVN presents itself as one of the best income plays in the sector with a strong annualized dividend yield.
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Hence, we are bullish on DVN stock at this time.
Another element that makes DVN mighty attractive is its valuation. The stock trades at 5.5x its cash flows on a trailing-12-months basis, roughly 27.5% lower than its five-year average. Moreover, its enterprise-value-to-EBITDA ratio sits at just 4.8x, 53% lower than its five-year average. Given its incredible long-term prospects and its strong fundamentals, it trades at a considerable discount.
Also, Devon Energy has a ‘Perfect 10’ Smart Score rating, implying that it can outperform the market, going forward.
Devon Energy: A Dividend Darling
To set itself apart from other energy companies, Devon Energy has launched what is considered by many a novel idea in the industry: a fixed-plus variable payment schedule. This new policy will allow them to provide sustainable base dividends while complementing those payments with up to 50% of quarterly free cash flow. Moreover, DVN utilizes the excess funds to strengthen its already top-notch balance sheet.
With an annualized yield of over 9%, the company has already boosted its base payouts while also retiring 4% of its stock. In addition, it boasts a robust balance sheet with below-target leverage ratios. Moreover, it is paying dividends to shareholders at a record rate, buybacks are up compared with last year’s levels, and the company still has plenty of cash flow left over after all these proactive moves. It’s using its windfall from higher prices this year to return even more money to shareholders’ pockets.
Devon Energy’s Spectacular Second-Quarter Results
Devon reported incredible second-quarter results recently marked by record free cash flow. Additionally, Devon’s operating and net margins increased substantially from the prior-year period.
DVN’s operating cash flow has grown by 145% compared to last year. This is largely thanks to accelerated earnings during 2021 due to the increased revenue from Russia/Ukraine-related economic activity. The company’s financial status continues its upward trend as its results nearly match last year’s full-year results despite being only halfway through this particular period.
Recent Acquisitions Should Boost DVN’s Growth Runway
The company has been acquiring firms rapidly, which is paying off. DVN announced an acquisition in June 2022 for Rimrock Oil & Gas, which boasts an incredible cash flow yield of 25%. Another acquisition was Validus Energy, which also boasts a remarkably high free cash flow yield of 30%.
Devon Energy’s recent acquisitions will provide it with a boost to its free cash flow, which should lead to higher dividends. The company is acquiring these assets for the long term so that it can still pay out more than what would have been expected had it not done any deals.
However, the recent funding of these acquisitions has left its net debt at an all-time high. Some might think that more debt always means bad news, but this isn’t necessarily true, as de-risking a low-risk asset doesn’t translate into stronger gains.
Moreover, despite its net debt soaring, it does not materialize as a problem because Devon started with a low level of leverage. This strategic decision has allowed management and shareholders to create value while maintaining financial stability when oil prices drop or achieve unrealistic valuations.
Is DVN Stock a Buy or Sell, According to Analysts?
Turning to Wall Street, DVN stock maintains a Moderate Buy consensus rating. Out of 14 total analyst ratings, seven Buys, seven Holds, and zero Sell ratings were assigned over three months.
The average DVN stock price target is $83.79, implying 21.3% upside potential. Analyst price targets range from a low of $61 per share to a high of $115 per share.
Conclusion: DVN Stock Has a Solid Risk/Reward Ratio
Investors are selling off cyclical stocks to de-risk their portfolios as the Federal Reserve looks set on slowing down economic growth. While this may not be considered one of the worst things you can do, I am starting to prefer positions with better risk/reward ratios, such as Devon Energy, which has been a favorite among investors lately due to its earnings potential and cheap valuation.
Its robust second-quarter results are a testament to its quality, and it should continue to post similar results, going forward. Moreover, its incredible dividend portfolio adds immense long-term value for DVN.
I’m glad to see that the Devon Energy acquisition spree won’t put too much strain on its finances, and thus, it will be a rare win-win for shareholders. Oil prices will still play an important role in future dividends. Nonetheless, at least these purchases should boost free cash flow regardless of what operating conditions we’re currently seeing now or are expecting next year.
