Exceptional Oil Company Shares Dip Almost 30%, Offering Potential Long-Term Investment Opportunity
Devon Energy's (DVN -0.09%) share price has plummeted approximately 30% from its highest points within the past year. This fall aligns quite closely with the declines witnessed in West Texas Intermediate crude, a significant benchmark for U.S. oil. Nevertheless, the focus for income investors is on the steady settlement of the dividend at $0.22 per share each quarter. Although the dividend is currently undergoing changes, Devon Energy remains an impressive oil company.
What is Devon Energy's Role?
Devon Energy is an unabashed upstream oil and natural gas producer. In simpler terms, the success of the company heavily depends on the price fluctuations of the commodities it produces. When energy prices are soaring, Devon's revenues and earnings gain strength. Conversely, when energy prices plunge, Devon's earnings and revenues weaken. Unlike integrated energy companies, Devon does not have any additional divisions to cushion the impact of these price fluctuations.
Because Devon's operations are focused mainly on the U.S. onshore market, it may lack the flexibility to shift investments and productions in a bid to maximize profits. West Texas Intermediate (WTI) crude serves as the principal benchmark when considering investments in Devon Energy. Keep in mind that in the past, there have been discrepancies between WTI and Brent crude (a global benchmark), which is largely due to operational constraints in the U.S. market.
Devon Energy can be considered a risky choice for those seeking to invest in the oil sector. Instead, conservative income investors might find it more profitable to put their money into an integrated energy giant such as Chevron. While Devon does have its drawbacks, it remains an appealing option for those seeking exposure to the oil sector.
The Growing Devon Energy
Should you manage to look past the inherent volatility of Devon Energy's business model, you will find that it is, in fact, one of the largest pure play upstream companies in North America. Its oil and natural gas production is more or less evenly divided, which makes it a viable investment option for those seeking exposure to both sources of energy. Devon also operates in some of the most prominent U.S. drilling basins.
The company anticipates that it has at least 10 years' worth of drilling inventory waiting to be explored. Moreover, its breakeven point when it comes to oil is a relatively low $40 per barrel. Devon Energy's investment-grade rated balance sheet is another attractive feature.
Just recently, Devon completed a merger that boosted its growth potential significantly. In pursuit of debt reduction, the company aims to pay down $2.5 billion, with $500 million set aside for repayment during the third quarter of 2024. This merger, while increasing the company's financial risk, has paved the way for significant growth opportunities.
In terms of its dividend, Devon has a variable policy. Beyond the base dividend payout of $0.22 per share each quarter, there is a variable payout that depends on the company's financial performance and objectives. At the moment, the dividend is only being paid at the base rate, which equates to a yield of around 2.2% when considering the current share price.
The prior quarter saw the variable dividend component totaling $0.22, amounting to a total payout that was double the current base rate. This decline in the total dividend payout might be responsible for the 30% decrease in Devon's share price, even though WTI per se has only dropped by around 22%.
For now, Devon Energy is not primarily focused on delivering income to its shareholders. The company's primary financial objective is debt reduction, which follows the merger. However, this financial commitment is actually advantageous for priority shareholders. Once Devon reaches its debt reduction goals, it will likely revert to paying its variable dividend again. When that happens, it will have an abundance of cash that is currently being used for debt reduction.
Simply put, Devon Energy is currently a direct play on U.S. energy prices with a minimal income payout. Given the United States' leading position as a global energy producer, it may be beneficial to include Devon Energy in a diversified portfolio for a year or two. In the short term, Devon Energy's income potential may take a back seat to debt reduction. However, in the long term, a reversion to the variable dividend policy would yield benefits for patient income investors.
Hedging Your Energy Exposure
As an investor, you are bound to be exposed to energy prices in your everyday life. This exposure may manifest itself in terms of home heating expenses or the cost of filling up your gas tank. If your power supplier relies on natural gas, energy prices might even affect your electricity bill. Investing in Devon Energy can, to some extent, provide a safeguard against rising energy prices, as it will likely see its stock price rise in tandem with increasing energy prices.
If, within a year or so, the variable dividend component is reinstated, Devon will not only serve as a price hedge - its dividend income will additionally safeguard investors against rising energy costs. This multi-faceted hedge is well worth considering, especially considering the United States' preeminent position in the energy sector. By including Devon in your investment portfolio, you can benefit from stock price appreciation as well as increased dividend income should the variable payout be reinstated. For the short term, Devon's income potential may be secondary to debt reduction. However, the potential for higher dividends in the future is an exciting development for income-focused investors.
Devon Energy's focus on upstream oil and natural gas production makes its earnings heavily reliant on finance-related factors, such as commodity prices. Therefore, intelligent investors might consider diversifying their investments in the energy sector by considering investing in a financially stable integrated energy company like Chevron, which can offer a more consistent income stream.
Furthermore, Devon Energy's current financial strategy is primarily focused on debt reduction, making its dividend payout variable and dependent on the company's financial performance. This strategy may not prioritize income generation now, but it holds great potential for income-focused investors in the long term, as the company aims to reinstate its variable dividend policy once its debt reduction goals are achieved.
