Devon Energy (DVN 0.19%) did it again. The oil and gas producer began reducing its dividend payout in the fourth quarter of 2022. Devon cut its dividend two additional times earlier this year. And now, the company is continuing the dismal trend with its fourth consecutive dividend reduction.
On Tuesday, Devon announced its second-quarter results. The company beat the consensus earnings estimate. However, it yet again slashed the dividend, this time to $0.49 per share from $0.72 per share. Should investors be worried?
Behind the decline
Devon pays a fixed-plus-variable dividend to shareholders. The fixed part isn't a problem. Instead, it's the variable part that's behind the latest dividend cut (as well as the three previous ones).
The variable dividend component is funded by up to 50% of excess free cash flow. When Devon's free cash flow falls, so does its variable dividend payout. And free cash flow has fallen.
In the second quarter, Devon generated free cash flow of $326 million. This marked the 12th consecutive quarter of positive free cash flow for the oil and gas producer. However, the trend hasn't been investors' friend. Devon's free cash flow in the first quarter of 2023 was $665 million. Before that, it was $1.1 billion.
Free cash flow usually tracks along with earnings. Unsurprisingly, Devon's earnings have also declined in recent quarters. The company's $690 million in net earnings reported in Q2 was the lowest level in two years.
Image source: The Motley Fool.
Some good news
Devon did give investors some good news. For one thing, the company achieved record oil production in Q2 of 323,000 barrels per day. It projects volume could increase to as much as 330,000 barrels per day in Q3.
Even better, Devon had what CEO Rick Muncrief called "highly commercial appraisal results" in the Wolfcamp B formation of the Delaware Basin. This effectively de-risks around 100 drilling locations.
Shareholders also benefited from what some call an "invisible dividend" -- stock buybacks. Devon repurchased 3.8 million shares in Q2. Since late 2021, the company has bought back 39.6 million shares for around $2.1 billion. The fewer shares in circulation, the greater the value the remaining shares hold.
Also, Devon retired $242 million in debt after the end of the second quarter. The company ended Q2 with a net debt-to-EBITDAX (earnings before interest, taxes, depreciation, amortization, and exploration expense) ratio of only 0.7 times. Now, its balance sheet is even stronger.
Wary vs. worry
Let's return to our original question: Should investors be worried about Devon's latest dividend cut? I don't think so. However, I do think that anyone who was banking on dividend yields of close to 10% that the company has offered in the past should be wary.
At the level dividends were paid in the first half of 2023, Devon's yield is around 4.6%. The company would need West Texas Intermediate (WTI) crude oil prices to approach $120 per barrel for its yield to top 10%. WTI crude is currently around $82 per barrel.
However, there are reasons to be optimistic. The Federal Reserve is no longer predicting a U.S. recession. That should bode well for oil and gas demand.
Devon's CEO thinks that the company has "a strong outlook for 2024." Muncrief said that Devon plans to keep its activity at steady levels and let any lower costs help boost free cash flow and cash returns to shareholders.
The bottom line is that the sword cuts both ways with a fixed-plus-variable dividend program. Dividend payouts will fluctuate along with free cash flow, which fluctuates with oil prices. Still, Devon's dividend should remain attractive for most income investors.
