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After a record year, Devon Energy will take its foot off the accelerator in 2024

Devon Energy (NYSE: DVN) increased crude oil production by 8% in 2023 to a record level for the company. The high-margin production generated strong free cash flow, and the oil company returned most of that money to shareholders through a flood of dividends and share buybacks.

However, Devon does not expect to set another production record in 2024. Instead, it plans to limit its capital expenditure, which will impact production. That strategy, however, positions the country to produce even more free cash in 2024 if oil prices cooperate, potentially giving it more money to return to investors.

A record year

On Tuesday, Devon Energy announced its fourth-quarter and full-year results. The Oil company produced 662,000 barrels of oil equivalent per day (BOE/d) in the fourth quarter, of which 317,000 barrels per day were oil. That exceeded the top of its guidance range. Meanwhile, total production for the year averaged 658,000 BOE/d (up 8% from 2022), while crude oil production averaged a record 320,000 barrels per day. The oil and natural gas company benefited from two acquisitions completed in 2022 (Validus Energy and RimRock Oil & Gas), as well as solid organic production growth fueled by its position in the Delaware Basin.

Devon’s record-breaking oil production helped the country generate $2.7 billion in free cash flow last year. While that was sharply lower than the record $6 billion it generated in 2022, it was still a solid result given that oil and natural gas prices were much lower while capital expenditures rose. Devon used that excess cash to pay out more than $1.8 billion in dividends (fixed and variable) and repurchase $979 million in stock. The company’s total dividend payments gave it a yield of 7% on the current share price. In the meantime, it has bought back 6% of its shares outstanding shares since the end of 2021.

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By 2024eefficiency will be the name of the game

Devon Energy does not expect 2024 to be another record year for oil production. The company recently reaffirmed its 2024 guidance for production to average 650,000 BOE/d, with crude output of approximately 315,000 barrels per day. That oil production level would be about flat compared to the 2023 outflow rate of 317,000 barrels per day. Meanwhile, natural gas production would decline as the company focuses on drilling in oil-focused regions with higher margins.

The company’s output will decline this year as it plans to cut capital expenditures by about 10% to a range of $3.3 billion to $3.6 billion. The driving force behind this decline is lower service costs and a focus on becoming more efficient.

“Looking ahead to 2024, we have designed a plan to deliver incremental improvements in capital efficiency,” CEO Rick Muncrief said in the fourth-quarter earnings press release. “By allocating additional capital to the core Delaware Basin and high-quality operations across our diversified portfolio, we expect to efficiently support our oil production with approximately 10% less capital.”

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The reduced capital expenditure will allow Devon Energy to generate more free cash flow this year. At an oil price of $80 per barrel (which is just above where West Texas Intermediate crude traded this week), it could produce $3.2 billion in free cash flow, about 20% more than last year.

Devon plans to return 70% of its free cash flow to shareholders through its base dividend (which will increase by 10% this year), share buybacks and variable dividends, while using the remainder to further strengthen its balance sheet. While management has historically prioritized variable dividends (with the goal of paying out up to 50% of excess free cash flow in variable dividends), it will shift its focus to share buybacks in 2024. With shares recently down more than 40% from the eight-year peak they reached in 2022, Devon is trading at a dirt-cheap valuation. It trades at a free cash flow yield of 9% at $75 per barrel of oil, three times higher than the broader market (suggesting it is significantly cheaper). Therefore, the company is on track to retire 9% of its outstanding shares while using what remains of its $3 billion buyback authority.

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There is a transition from growing crude oil production to free cash flow

Devon Energy delivered record oil production last year. However, that production growth did not create value for investors. That’s causing management to shift gears to focus on growing free cash flow. The company hopes that producing more cash and using it to buy back its now cheap shares will help fuel stronger returns in 2024. That potential recovery makes Devon Energy an attractive investment opportunity today.

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Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

After a record year, Devon Energy takes its foot off the gas in 2024, originally published by The Motley Fool

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