ExxonMobil (NYSE: XOM) is a solid and worthy dividend stock candidate for investors looking for oil exposure, but it doesn’t trade at Devon Energy‘S (NYSE: DVN) cash flow valuation. Furthermore, while ExxonMobil stock is up nearly 19% this year, Devon stock is flat this year, offering excellent value for investors. Here’s why.
Devon Energy continues to make progress
Devon Energy’s recent second quarter results included several positives that helped validate the investment case for the stock, including the company’s improved production target. In a year where management decided to focus investments on its core assets in the Delaware Basin, it’s reasonable to expect an improvement in well productivity and total production. Management started the year by forecasting a 10% improvement in well productivity and production of 650,000 barrels of oil equivalent per day (Boe/d) by 2024.
The good news is that management has reaffirmed its productivity improvement target and raised its full-year production target for the second time this year to a new range of 677,000 Boe/d to 688,000 Boe/d — a 5% upgrade from the original target. It’s an even better result when you consider that oil prices started the year around $70 a barrel, but have spent most of it above $75 a barrel.
Cash flow valuation
As noted above, Devon Energy trades at a more attractive valuation than many other oil stocks. For example, Wall Street analysts expect ExxonMobil to generate $34.7 billion in free cash flow (FCF) by 2024. Based on ExxonMobil’s current market cap of $527.5 billion, that FCF is equal to 6.6% of the company’s market cap.
It’s an attractive cash flow yield, but Devon’s is even higher. Based on the company’s market capitalization of around $26.8 billion at the time of the results, Devon’s management believes it will trade at a 9% FCF yield at $70 a barrel in 2024, 11% at $80 a barrel, and 13% at $90 a barrel. Looking at the current market cap, those numbers work out to around 8.5% at $79 a barrel, 10.3% at $80 a barrel, and 12.2% at $90 a barrel.
With oil prices now at $76 per barrel, Devon is clearly trading at a very attractive FCF valuation.
A takeover is not in the figures
Devon management expects to complete the acquisition of Grayson Mill Energy’s Williston Basin operations for $5 billion ($3.25 billion in cash and $1.75 billion in stock) by the end of the third quarter. Investors should note that neither the improved production outlook nor the FCF yield calculations assume any accretion from this acquisition in 2024.
Capital allocation policy
Devon Energy’s capital allocation policy is to use 30% of the FCF to support the balance sheet, partly in connection with the acquisition. (Devon will embark on a $2.5 billion debt reduction program.) The remaining 70% will be used for share buybacks, a fixed quarterly dividend of $0.22 per share and a variable dividend.
The total dividend in the first quarter was $0.35 per share and $0.44 per share in the second quarter, with management prioritizing share buybacks over the variable dividend. While some investors may not like that, it reduces the number of shares issued and increases the claim of existing shareholders on future cash flows.
To put things into perspective, the FCF yields mentioned above make it clear that Devon could potentially pay significantly higher dividends if it wanted to. However, the idea of ​​investing in a company is that management can generate better returns on investment than an investor, so it makes sense to let them do that by locking up cash to add value.
A stock to buy
Devon’s FCF generation (which will be boosted by the acquisition in the third quarter) and its policy of returning cash to shareholders in the form of share buybacks and dividends means that investors can expect significant returns from Devon in the coming years, provided oil prices remain relatively high.
Should You Invest $1,000 In Devon Energy Now?
Before buying Devon Energy stock, you should consider the following:
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Lee Samaha 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.
Forget ExxonMobil: Buy This High-Yielding Dividend Stock Instead was originally published by The Motley Fool
