ExxonMobil (NYSE: XOM) is a fine and worthy dividend-stock candidate for investors looking for exposure to oil, but it doesn’t trade at Devon Energy‘s (NYSE: DVN) cash-flow valuation. Moreover, while ExxonMobil’s stock is up almost 19% this year, Devon’s stock is flat this year and presents an excellent value for investors. Here’s why.
Devon Energy continues to progress
Devon Energy’s recent second-quarter results contained several positives that helped confirm the investment case for the stock, including the company’s upgraded production target. In a year when management decided to focus investment in its core assets in the Delaware Basin, it’s reasonable to expect an improvement in well productivity and total production. Indeed, management started the year predicting a 10% improvement in well productivity and the production of 650,000 barrels of oil equivalent per day (Boe/d) in 2024.
The good news is that management reaffirmed the target for well-productivity improvement and, for the second time this year, upgraded its full-year production target 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 considering that the price of oil started the year at around $70 a barrel but has 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) in 2024. Based on ExxonMobil’s current market cap of $527.5 billion, that FCF is equivalent 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 cap of around $26.8 billion at the time of the results, Devon’s management believes it will trade at a 9% FCF yield at a price of oil of $70 a barrel in 2024, 11% at $80 a barrel, and 13% at $90 a barrel. Looking at the current market cap puts these figures at roughly 8.5% at $79 a barrel, 10.3% at $80 a barrel, and 12.2% at $90 a barrel.
With the current price of oil at $76 a barrel, Devon clearly trades at a very attractive FCF valuation.
An acquisition isn’t in the numbers
Devon’s management expects to complete the acquisition of the Williston Basin business of Grayson Mill Energy 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 upgraded production forecast nor the FCF yield calculations assume any contribution from this acquisition in 2024.
Capital-allocation policy
Devon Energy’s capital allocation policy targets using 30% of FCF to support the balance sheet, partly in connection with the acquisition. (Devon will initiate a $2.5 billion debt-reduction program.) The remaining 70% will be used for share repurchases, a quarterly fixed 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 repurchases over the variable dividend. While some investors may not like that, it reduces shares in issue and increases the claim of existing shareholders on future cash flow.
Putting things into perspective, the abovementioned FCF yields make it clear that Devon could potentially pay significantly higher dividends if it so desired. However, the idea of investing in a company is that management can generate better returns on investment than an investor can, so it makes sense to let them do that by retaining 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 ensures that investors can look forward to significant returns from Devon in the coming years, provided the price of oil stays relatively high.
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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-Yield Dividend Stock Instead was originally published by The Motley Fool
Source: finance.yahoo.com