Devon Energy (DVN 0.45%) is a $32 billion market cap energy producer with a focus on U.S. onshore drilling. The most notable feature of the stock, however, is probably the huge 9.2% dividend yield. If you are a dividend investor looking for energy exposure, that's likely to sound alluring. But don't buy Devon without a full understanding of its dividend policy. It won't likely be attractive to most income investors, but it might be just what some are looking for.
What goes up...
Devon Energy drills for and sells oil and natural gas. There are nuances to the business, but the big driver of top- and bottom-line performance is going to be energy prices. Even production levels, which are important and hitting all-time highs today and up and impressive 11% year over year, will likely be overshadowed by commodity prices, noting that oil and natural gas are prone to swift and dramatic price swings. That's just the way the energy sector works, and there's little that Devon or any other company can do about it. For example, even a low break-even production cost of around $40 a barrel and active hedging can soften the price swings, but it can't eliminate them.
Image source: Getty Images.
So, for better or worse, Devon Energy's earnings can be pretty volatile over time. A good quarter or year, or even a streak of good years, will, with history as a guide, eventually be followed by hard times. The way the company has tried to address this simple fact while rewarding investors is to tie the dividend to its financial performance. This is a relatively new development, but one that makes material sense.
Essentially, Devon pays a small dividend that it believes is sustainable over the long term in both good and bad energy markets. It then augments that with a supplemental dividend that goes up and down (potentially to zero) based on how well the company is performing. The real-world translation of this is that when energy prices are high, shareholders should expect larger dividends, and when prices are low the dividend will be smaller. It's a reasonable proposition as long as you understand the policy before you buy the stock.
Good or bad...for you?
The big takeaway from the dividend policy is that investors simply can't rely on the dividend yield as a gauge of future dividends. Sure, the 9.2% yield today is very attractive, but the dividend has been cut three quarters in a row at this point as oil prices, and thus the company's financial performance, have been heading lower. If you are a dividend investor looking to create a reliable and consistent income stream, Devon Energy will probably be a terrible choice for your portfolio.
DVN Dividend Per Share (Quarterly) data by YCharts
But that doesn't mean it won't be a fit for some investors. Energy is a commodity that directly impacts consumers in various ways, from the cost of gasoline to the cost of heating a home. When oil and natural gas prices are rising, investors are likely to feel a hit to their pocketbook. Devon Energy's dividend policy could offer an offset.
NYSE: DVN
Key Data Points
It is not a one-to-one relationship or an exact science, but generally speaking when energy prices are rising, Devon's dividend will likely end up being increased. There's a lag to that, given that the dividend will be based on actual performance and not raised in advance even if oil prices are shooting higher. But as you are shelling out more for gasoline, an investment in Devon is likely to provide you with more dividend income. And when energy prices are dropping, easing the hit on your pocketbook, Devon's dividend will likely decline. All in, Devon's dividend policy is built to provide you with a cash infusion right when you need it to cover rising energy costs.
A niche investment
The dividend isn't the only way that Devon Energy returns value to shareholders, noting that it has increased its stock buyback plan by 50% to $3 billion. That said, buybacks are merely a promise and, in the end, are also reliant on financial performance. All in, most dividend investors looking for energy exposure will likely be best served by an integrated energy major with a consistent history of paying dividends, like Chevron or ExxonMobil.
But Devon's performance-linked dividend, as it stands today (dividend policies can and do get changed), could offer more active dividend investors a way to deal with the everyday budget issues posed by volatile energy prices. That's likely to be a small subset of investors, but if this somewhat unique dividend approach resonates with you, Devon could be just what you have been looking for.
