What happened
The S&P 500 peaked on Jan. 3 of last year. It has been almost all downhill since then. The index shed 20% of its value by year-end, putting it in bear market territory.
Devon Energy (DVN 0.79%), however, didn't get the memo that we're in a bear market. The oil company significantly outpaced the broader indexes, rising almost 35% since the onset of the downturn, according to data provided by S&P Global Market Intelligence. Here's a look at what fueled Devon's remarkable return and whether it can continue producing strong results for its investors.
So what
Devon Energy capitalized on higher crude prices last year. The oil company produced $2.1 billion of free cash flow during the second quarter, the highest level in its 51-year history. While cash flow declined from its peak as oil prices cooled off during the third quarter, Devon still produced a robust $1.5 billion in free cash.
The oil company returned the bulk of that windfall to shareholders, thanks to its fixed-plus-variable dividend strategy. That policy sees Devon pay out a fixed base dividend it can sustain at lower oil prices. In addition, it pays a variable dividend of 50% of its free cash flow after covering that base payout. With oil prices surging last year, Devon's dividend payments soared.
Data source: Devon Energy. Chart by the author.
Devon used its remaining windfall to strengthen its already top-notch balance sheet, repurchase shares, and acquire more cash-flowing oil assets. By the end of the year, Devon's leverage ratio was 0.5, which was 50% below its 1.0 target. The company had also repurchased $1.3 billion in stock through the end of the third quarter, reducing its outstanding shares by 4% versus the same period in 2021. Finally, it spent a combined $2.5 billion in cash to acquire RimRock and Validus, bolstering its position in two key oil basins.
Now what
Devon Energy faced some weather-related headwinds in the fourth quarter. Because of that and lower oil prices in the period, the company's free cash flow and dividend will likely be below the peak even after accounting for the incremental cash produced by RimRock and Validus.
If oil prices continue to decline, Devon's cash flows and dividend will follow suit, which could put pressure on its shares. However, many in the oil patch believe crude prices will heat back up in 2023. They foresee several factors impacting supply, while demand should strengthen as Asian economies recover from pandemic-related lockdowns. These catalysts could push crude prices back into the triple digits. If that happens, Devon Energy's stock could be a big winner again in 2023.
