Shares of Devon Energy (DVN 0.19%) have gone from white-hot to ice-cold over the past few months. The oil company's stock initially surged along with crude prices last year. However, they've cooled off considerably in recent months and are now about 30% below their peak due to lower oil prices, a falling dividend, and a higher capital spending plan.
Because of that sell-off, shares of Devon look very attractive these days, especially compared to broader market indexes like the S&P 500 and Nasdaq Composite. Here's a closer look at this dirt cheap energy stock.
A bottom-of-the-barrel valuation
Devon Energy recently released its 2023 outlook:
Image source: Devon Energy investor relations presentation.
As that slide notes, the company expects to invest $3.6 billion to $3.8 billion in capital on drilling wells and to build related infrastructure to help grow its production by about 9% per share versus 2022. Devon can fund that capital plan at a $40 price point for West Texas Intermediate (WTI) crude oil. Given its assumption that oil will average $80 a barrel this year (a little below the recent price in the high $70s), the company expects to produce more than $2.5 billion in free cash flow.
At its current market cap and free cash flow estimate at $80 WTI, Devon trades at a free cash flow yield of 8%. That's almost twice the free cash flow yield of the major market indexes. This higher yield implies that Devon's shares trade at a much lower valuation than the broader market averages.
Meanwhile, shares are even cheaper if oil prices rebound. While crude has cooled off in recent months, several catalysts could drive oil prices higher this year. That would enable Devon to produce even more free cash flow in 2023.
Taking advantage of the opportunity
Devon plans to continue returning most of its free cash flow to shareholders. The company's dividend policy sees it make a fixed-base quarterly payment (which it recently increased by 11%). In addition, it returns up to half its post-base-dividend free cash flow to investors each quarter via a variable dividend. It uses the other 50% of its excess cash to strengthen its balance sheet, make accretive acquisitions, and repurchase shares.
The company's current buyback program is having a big impact because of its dirt cheap valuation. Devon had spent $1.3 billion of its $2 billion share repurchase program to retire 26 million shares through the end of the fourth quarter, reducing its outstanding shares by about 4%.
Devon will likely continue buying back shares hand over fist. It slowed its repurchase pace in the second half of last year because it funded two sizable acquisitions and wanted to rebuild its cash position. However, with over $1.5 billion in cash and more cash flowing into the business, it has the funds to continue buying back stock.
CFO Jeff Ritenour noted on the quarterly conference call:
Our expectation here in the first quarter and moving into the second quarter is it will look more like the pace that you saw from us in the first half of last year as it relates to the buyback. And particularly on days like today, where we're trading off relative to the group, that's a point in time where you're going to see us be real opportunistic and aggressive, getting into the market and buying our shares back.
The company has about $700 million left on its current authorization, which expires in May. That gives it lots of room to buy back its beaten-down shares. Meanwhile, it can expand and extend that authorization, giving it more fuel for opportunistic repurchases this year.
An attractive value these days
Devon Energy trades at a relatively cheap valuation these days based on the free cash flow it can produce at $80 oil. That's leading the company to buy back its stock. Meanwhile, it's even cheaper if oil prices rebound this year, as many industry experts expect. These factors make it an attractive oil stock for those seeking value and upside potential.
