Devon Energy Stock Sinks on Dividend Safety Fears

What happened

Shares of Devon Energy (DVN 0.58%) tumbled 4.6% this morning within minutes of the market's opening. The broader markets were falling, and so were oil prices on fresh developments in China. Energy investors are now increasingly worried about Devon Energy's dividend safety, especially after the upstream oil and gas company paid out a smaller dividend in its last quarter.

So what

Devon stock gained immense popularity among energy investors after the company started paying out a fixed-plus-variable dividend last year. The dividend has grown manifold in the past year or so, and investors in the stock were minting a lot of money until oil prices started to cool in recent weeks. The sell-off in oil has only intensified.

This morning, the price of U.S. benchmark West Texas Intermediate (WTI) crude slumped more than 1% to levels not seen in nearly 11 months as COVID-19 cases continued to rise in China. The nation's zero-COVID policy and strict lockdowns sparked widespread protests across major Chinese cities this past weekend and added fuel to the market's fears about a potential fall in demand for oil from that nation.

Falling oil prices could mean lower dividends for Devon's shareholders in the near future. The energy company's quarterly dividend has two components: a fixed base dividend of $0.18 per share, and a variable dividend of up to 50% of the excess cash flows (or cash flows remaining after accounting for its capital expenditures and fixed base dividend).

In the third quarter, for example, Devon paid a total dividend of $1.35 per share. That alone makes it evident that the monster payouts in recent quarters were almost entirely because of its variable component, which grew rapidly alongside the company's cash flows.

With oil prices on the decline, Devon will generate lower cash flows, and therefore pay a smaller dividend. That's what investors are worried about, and why they are dumping the oil stock in fear.

Now what

While it's true that Devon's dividend fluctuates with oil prices, and that lower oil prices will most likely mean lower passive income for shareholders, there's no reason to sell the stock. Devon is on strong footing and is focused on strengthening its financial standing while growing both organically and inorganically. Even if Devon has a lower dividend in the fourth quarter, it could still be a decently big payout from a stock yielding 7.9%.