Chevron (CVX 2.95%) recently made headlines after agreeing to spend $7.6 billion to acquire PDC Energy (PDCE). The deal surprised many because Chevron's acquisition will make it a leading producer in Colorado's DJ Basin instead of significantly boosting its position in the Permian Basin. Chevron opted to bulk up in that lesser-known region because the deal is so accretive. The acquisition will increase its proved oil equivalent reserves by 10% for less than $7 per barrel while adding $1 billion to its annual free cash flow.
Fellow DJ Basin producer Civitas Resources (CIVI 6.47%) recently went in the opposite direction, unveiling transformative transactions to enter the Permian Basin. The highly accretive deals will significantly boost its free cash flow, enabling Civitas to increase its dividend by 20% next year. Here's a closer look at the oil dividend stock's deal and how it differs from Chevron's acquisition.
Drilling down into Civitas' deals
Civitas Resources has agreed to acquire oil-producing assets from Hibernia Energy III and Tap Rock Resources, portfolio companies of funds managed by NGP Energy Capital Management. It's paying $2.45 billion ($1.5 billion in cash and 13.5 million shares) to acquire 30,000 net acres owned by Tap Rock in the Delaware Basin side of the Permian. Meanwhile, it's spending $2.25 billion in cash to buy Hibernia's Midland Basin assets, which include 38,000 net acres.
The deal is truly transformative for Civitas Resources. It will increase the company's combined production rate by 60%. Meanwhile, it's paying a fair price of three times estimated 2024 EBITDAX (earnings before interest, depreciation, amortization, and exploration), which aligns with recent Permian transactions. The company estimates the deal will boost its free cash flow by $1.1 billion next year while increasing the per-share total by 35%, assuming oil averages $70 a barrel and natural gas averages $3.50 per MMBtu (the same assumptions Chevron used for its deal).
That free cash flow uplift drives Civitas' view that it will be able to increase its pro forma dividend by about 20% next year. The company has a similar dividend framework to Devon Energy (DVN 2.56%). Like Devon, it pays a fixed base dividend and a variable dividend. During the first quarter, Civitas' combined payment rate gave it an annualized dividend yield of more than 12% at the recent share price, almost double Devon's dividend yield, in part because of Civitas' much lower valuation. Civitas trades at a more than 15% free cash flow yield at $75 oil, while Devon's free cash flow yield is around 9% at that oil price point.
Meanwhile, the company expects to end next year with a leverage ratio of less than 1.0, up from a net cash position at the end of the first quarter. It aims to achieve its target by reducing its share repurchase authorization from $1 billion to $500 million while also planning to sell $300 million in non-core assets.
A differentiated approach
Location is one of several key differences between Civitas' transformative transactions and Chevron's recent acquisition, all of which increase risk. Chevron will bulk up on an existing area while Civitas enters a new one, which adds integration risk. Civitas is increasing its oil output (increasing its climate change risk), while Chevron's deal will lower its carbon intensity by increasing its exposure to natural gas. Finally, Chevron will issue stock to finance its deal while Civitas is taking on debt to complete its transformative transactions (increasing balance sheet risk).
That funding approach is noteworthy. Chevron's CEO Mike Wirth stated on the company's first-quarter conference call: "We tend to use equity for M&A because commodity prices are volatile. It creates a more stable deal structure." By using its shares to buy PDC Energy, Chevron will preserve its balance sheet strength, giving it the flexibility to continue delivering on its financial priorities (grow the dividend, invest in expanding its business, maintain a strong balance sheet, and repurchase shares) during periods of lower oil prices.
Civitas is taking the opposite funding approach. It's only issuing about $950 million in equity to finance its two deals or about 20% of the purchase price. It's financing the balance with cash on hand ($400 million), its credit facility ($650 million), and new debt ($2.7 billion). The company recently launched offerings to issue $1.35 billion of notes due in 2028 and $1.35 billion due in 2031.
While the company has the balance sheet strength to finance these deals with debt, the strategy could come back to bite it in the future. If oil prices plunge, Civitas might have trouble paying the interest on the debt or refinancing it in the future. That could affect its ability to fund its capital program, pay dividends, and repurchase shares. On the other hand, by issuing equity to fund its deal, Chevron will preserve its financial flexibility for the next industry downturn.
A higher-risk, higher-reward deal
Civitas is making a bold bet that oil prices will remain robust by using debt to complete a transformational transaction to enter the Permian Basin. If oil remains elevated, the deal could pay off by enabling the company to generate lots of cash to pay dividends. However, if oil tumbles, the debt-funded deal could backfire. That means Civitas has a much higher risk profile (and reward potential) than Chevron.