Oil prices flip-flop between being in a bull or bear market rather frequently. Last year, a bull rush following Russia's invasion of Ukraine sent oil into the triple digits. It has been all downhill since then, with crude getting cut by a third over the past year.
While oil is currently in a bear market, a bull market is coming. Here are three reasons why now is a great time to buy shares of Devon Energy (DVN 0.19%) ahead of the next oil bull market.
Positioned for higher oil prices
The International Energy Agency currently expects oil demand to grow by 2.4 million barrels per day (BPD) this year to an average of 102.3 million BPD. That's 400,000 BPD higher than its April forecast, fueled by record-breaking Chinese demand and strong demand in India.
That strong demand growth is coming when supply growth remains constrained. U.S. producers are staying disciplined, keeping a lid on the country's supply growth. That's allowing OPEC to manipulate supply by cutting its output in hopes of boosting crude prices. Growing demand and tightening supplies should create a supply deficiency during the second half of the year. That shortfall should drive up crude prices.
Higher oil prices will allow oil stocks like Devon Energy to produce more cash. As the following chart showcases, there's a distinct correlation between oil prices, Devon's cash flow, and its stock price:
Higher oil prices would mean a higher dividend
Oil prices also directly affect Devon Energy's dividend payments because of its fixed-plus-variable framework. Like many companies, Devon pays a fixed dividend each quarter. In addition, the company launched a trailblazing variable dividend a few years ago. It pays up to half its free cash flow (after funding the base dividend) to shareholders in variable dividends each quarter. That payment rises and falls with its oil-fueled cash flows:
Data source: Devon Energy. Chart by the author.
While the overall payment has fallen over the past few quarters, it will start rising as oil prices rebound. That would provide investors with even more dividend income. Even at its currently lower rate, Devon provides an annualized dividend yield of more than 6% at the recent share price.
Capitalizing on the downdraft
Devon Energy has the flexibility to use the other half of its free cash flow to create additional value for shareholders through debt reduction, acquisitions, and share repurchases. This year, the company has focused on buying its shares following their sell-off. CEO Rick Muncrief stated on the first-quarter conference call:
We continue to see attractive value in repurchasing our shares, which we believe traded a significant discount to our intrinsic value. To capitalize on this compelling opportunity, we made substantial progress advancing our buyback program by repurchasing $692 million of shares year to date. In addition to our corporate buyback activity, multiple members of our management team, myself included, have also demonstrated their conviction in Devon's value proposition by purchasing stock in the open market over the past few months.
That view led the company to boost its repurchase program by 50% to $3 billion. That's enough to retire 9% of its outstanding shares. Devon's rising cash flows as oil prices rebound would give it more money to buy back shares, which should help drive the stock higher during a bull market.
Cash in on the upcoming rally
Oil prices seem likely to rebound in the second half of this year, fueled by a growing gap between supply and demand. That would enable Devon to generate more cash to pay dividends and repurchase shares. This increased cash flow and cash returns should drive its share price higher. That upside opportunity makes Devon look like a great oil stock to buy before the next bull market in oil begins.
