Considering Oil Prices Remain Under the $70 Mark, Is Purchasing Devon Energy Shares Wise?
Crude oil prices have experienced significant fluctuations this year. At one point, WTI, the main U.S. benchmark, reached over $85 per barrel. However, it's currently showing a modest decrease for the year, hovering around $69 a barrel recently.
The fluctuation in oil prices significantly impacts the revenue streams of oil companies like Devon Energy (DVN 0.29%). Let's examine if the current oil price trajectory influences the investment argument for this oil company's stock.
Counteracting the oil price drop
Devon Energy reported an operating cash flow of $1.7 billion during the third quarter, marking an 8% increase compared to the previous quarter. This improvement was achieved despite a decline in the average price of oil sold, which dipped from $78.95 in the previous quarter to $74.26 during the current period. Devon managed to mitigate the oil price decrease by increasing its overall production by 4%, attributable to its strong position in the Delaware Basin across Texas and New Mexico, as well as its acquisition of Grayson Mill Energy, which was finalized near the end of September. Additionally, Devon saw a 7% decrease in production costs.
The strategic timing of the Grayson Mill Energy deal is noteworthy. Devon did not fully benefit from the deal in the third quarter, as it anticipates this acquisition to significantly boost its cash flow. Devon purchased Grayson Mill Energy at a double-digit free cash flow yield. Furthermore, it aims to cut costs through synergies and exploit Grayson Mill's midstream assets in the Williston Basin region of North Dakota and Montana, which could potentially earn higher prices for its production in the area.
While lower oil prices may present a challenge to Devon, its increased production, lower costs, and the highly accretive Grayson Mill Energy deal serve as a buffer.
Scrap cleanup, at rock-bottom prices
Devon projects generating substantial cash flow next year, even if oil prices continue to deteriorate. It is capable of producing $1.5 billion in free cash flow at a $60 oil price and over $2.5 billion if oil averages $70 a barrel. In comparison to its current market cap, Devon trades at a 5% free cash flow yield at $60 oil and 9% if oil averages $70 a barrel. This is much cheaper than the broader market, which is trading at a single-digit free cash flow yield.
The cost-effectiveness of Devon's stock has spurred its focus on using more of its excess free cash flow to repurchase shares. Devon generated $786 million in free cash flow during the third quarter. The company used its excess cash (combination of free cash flow and balance sheet cash) to pay its quarterly dividend, retire $472 million of debt at maturity, and repurchase $295 million of its stock. Devon chose not to offer a variable dividend in the quarter, instead opting to strengthen its balance sheet post-Grayson Mill Energy deal and to buy back its shares.
Moving forward, Devon aims to return 70% of its free cash flow to investors (keeping the remaining 30% to bolster its balance sheet). Dividend growth remains its primary objective. Subsequently, considering its current attractive valuation, it intends to prioritize repurchasing its shares over providing a variable dividend.
Since launching its share repurchase program in late 2021, Devon has repurchased $3 billion of stock. In conjunction with the Grayson Mill Energy deal, Devon expanded its share repurchase authorization to $5 billion, which it hopes to finalize by mid-2026. This larger buyback demonstrates its confidence in buying back its shares as a worthwhile investment in the current environment.
Devon Energy, still a steal below $70 a barrel
Devon expects to continue generating massive free cash flows over the next year, even if oil prices continue to decline. As a result, it will still hold an attractive valuation even if oil falls below $60. This is why it is focusing on repurchasing shares at present. Consequently, if you're seeking a value play in the oil sector, Devon still appears like a viable buy, with crude prices falling below $70 a barrel.
Given the current oil price trajectory, investors might question if Devon Energy's stock remains a viable investment. However, the company's operating cash flow of $1.7 billion during the third quarter, despite a decrease in oil prices, indicates its resilience in the face of finance challenges related to investing in oil. Furthermore, Devon's strategic acquisition of Grayson Mill Energy and its focus on share repurchases position it as a potential value play in the oil sector, even if crude oil prices continue to hover around $69 a barrel.
