Devon Energy: An 8% Dividend Stock That Might Be Right For Your Portfolio (NYSE:DVN)

Devon Energy (NYSE:DVN) continues to witness strong results as energy prices and improving production continue to provide a tailwind to the company. Devon is an energy company primarily engaged in hydrocarbon exploration in the United States. They currently have between 1600-1800 million (barrel oil equivalent) BOE of oil compromising petroleum, natural gas, and natural gas liquids.

Energy Outlook Remains Strong

Oil and natural gas prices have come down slightly recently, with the latest price, WTI $74, and Brent currently trading at $80 a barrel. On the other hand, natural gas prices currently trade at $2.4 on the Henry Hub spot. The current environment with the cooler weather, and increasing demand from multiple countries including China, and other developing markets means that end demand continues to rise, even though the supply remains tight.

The cost of exploration and fewer barrels of oil being explored has led to an environment where oil supplies remain tight; as a result, global oil prices have likely made a complicated bottom and will likely remain elevated in the future. Moreover, beyond exploration issues, OPEC has indicated it does not wish to increase supply, and other major oil-producing countries agree with the bloc. All these factors will continue to provide a tailwind to oil in the near future, which should create a longer-term favorable environment for oil stocks. Yes inventories continue to increase, but the overall situation remains relatively fragile.

Furthermore, investors recently took money off the table, as a strong jobs report meant that US interest rates are likely to continue to increase in the near future. This means both a stronger dollar and the likelihood of falling liquidity, could push down oil prices in the near future. But overall demand-and-supply dynamics are clearly in favor of the company and could see oil heading back above $100 soon.

Financial Outlook

Despite the favorable backdrop, Devon’s management has indicated that it will continue operational execution as planned. Production plans are expected to be anywhere from 570,000 to 600,000 BOE, with capital spending coming in at around $2 billion for the coming year.

The current assets of the company including its recent acquisitions have allowed the company to continue to increase production and ensure that production remains on the higher side at 614,000 BOE/per day, with a run rate of around $2.4 billion in capital spending.

Revenue is expected to come in at around $19-20 billion for the year, but if energy prices increase, that number could increase to $20-21 billion for the year, thereby increasing cash flow significantly. The current operating margin for Devon energy is expected to be around 30-35%, and the net income margin is expected to come in at approximately 25%. That would translate into a net profit of about $4.5-5 billion for the year, bringing forward price-to-earnings (P/E) to around 5x, and at that valuation, the stock could be considered relatively cheap. In addition, one-time operational costs added about $7 per barrel in the previous quarter, and those costs should no longer be present in the coming quarters, thereby increasing operating profits during the next couple of quarters.

Meanwhile, 2023 could see slightly higher oil prices, and that would combined with increasing levels of production could mean revenue increases by a further 10-15%, with total revenue coming in around $23-24 billion.

Management’s Outlook

Management continues to focus on operational efficiency and maintaining discipline. They continue to emphasize that oil prices are volatile, but remain optimistic and continue to increase production as the increase in capacity from the Delaware basin continues to support output. Furthermore, management is focused on bringing net debt to 0 by the end of the year by retiring debt due in 2022 and 2023 on an earlier timeline. They have also stated that the return on capital employed should rise to 40% this year as cash flow increases, which should only further help push the stock price up.

The Delaware Basin, the Anadarko basin, and the Williston Basin, all are witnessing improved production, with new recoveries in Delaware and improved production in the Anadarko basin.

Due to the impact of acquisitions, Devon is revising its production forecast higher in the fourth quarter to a range of 640,000 to 660,000 Boe per day, a 6 percent increase compared to the year-ago quarter. This fourth-quarter volume growth will be driven by 35,000 Boe per day of incremental production from the company’s Eagle Ford acquisition.

The company also adjusted the midpoint of its upstream capital outlook to $835 million for the upcoming quarter. This guidance incorporates $120 million of incremental capital requirements related to recent bolt-on acquisitions in the Eagle Ford and Williston Basin.

Economic headwinds could weigh on the stock

The price of oil continues to increase as global demand remains robust. But consumers are increasingly struggling as inflation takes a toll on purchasing power. In addition to inflation, rising interest rates will affect the economy, and due to lower consumption and investment, overall energy demand should come down from 2021. Both these factors are likely to put downward pressure on oil prices. In addition, supply from countries like Venezuela may also affect oil prices, further depressing prices.

And as the Fed continues to tighten, higher rates and quantitative tightening are likely to reduce the overall liquidity in the market. All these factors are headwinds and should be considered before investing. Historically shale-oil stocks have always been volatile, and while balance sheets are much more stable than before, liquidity risk always remains an issue

Financial Outlook and Dividend Strategy

Devon Energy is currently maintaining an 8% dividend and cash flow should continue to support this level of dividend for a few more quarters. Should oil prices decline further, that dividend would likely be cut to around 4%. as management pulls back on capital spending and dividends. This means that the stock might be under pressure, despite the fact that the current valuation remains cheap.

Overall, the future remains strong with a strong level of assets continuing to push Devon toward profitability. And while oil prices have remained rangebound for now if the outstanding reserves and supplies continue to decline, oil prices are likely to head back higher.