Devon Energy (DVN 0.19%) has been a winning stock since closing its transformational merger with WPX Energy in early 2021. The transaction turned it into a free cash flow machine. That gave it the fuel to grow value for its investors through dividends, share repurchases, debt reduction, and acquisitions. The company's adept use of its cash flow has helped power a nearly 190% total return since the merger closed (40.6% annualized), easily beating the S&P 500's roughly 40% (11.4% annualized) total return during that period.
The oil stock should have plenty of fuel to continue growing shareholder value in the future. Here's a look at what drives that view.
Its transformational transaction has delivered results
When Devon Energy closed its merger of equals transaction with WPX Energy in early 2021, the company believed the deal would significantly enhance its ability to generate free cash flow. "This transformational merger enhances the scale of our operations, builds a dominant position in the Delaware Basin and accelerates our cash-return business model that prioritizes free cash flow generation and the return of capital to shareholders," stated Devon's executive chairman Dave Hager at the time.
The company used that merger as a springboard to launch the industry's first fixed-plus-variable dividend framework. Devon intended to pay a fixed base dividend that would increase each year. On top of that, it targeted to return up to 50% of its excess free cash to shareholders through a variable dividend. Since launching the framework, Devon has nearly doubled its base dividend rate while paying significant variable dividends:
Data source: Devon Energy. Chart by the author.
The company's variable payment surged along with oil prices (and its oil-fueled cash flows) during the first half of 2022. While lower oil prices impacted its cash flow over the past few quarters, Devon still produces lots of cash to pay dividends.
In addition to paying dividends, Devon uses its gushing cash flows to repurchase shares, repay debt, and make acquisitions:
Image source: Devon Energy.
The company has repurchased over $2.1 billion in stock since late 2021, retiring 6% of its outstanding shares. Meanwhile, it has strengthened its balance sheet by repaying $1.5 billion of debt since the merger closed, reducing its leverage ratio to less than 1.
Devon has also made two cash-gushing acquisitions. It paid $865 million to acquire the leasehold interests and related assets of RimRock Oil & Gas in mid-2022. The highly accretive deal enabled Devon to increase its base dividend by 13%. The company followed that acquisition up with a $1.8 billion deal for Validus Energy in late 2022. The cash-gushing acquisition gave Devon more fuel to pay variable dividends, helping offset some of the decline in oil prices.
Plenty of fuel to continue paying dividends
Devon Energy expects to continue producing lots of cash. The oil company estimates it could generate $3.2 billion in free cash flow this year, assuming that oil averages around $80 per barrel (slightly above the recent price). That would be a more than 20% improvement from last year's level, fueled by lower service costs and its focus on investing in its highest-return drilling locations.
The company aims to return 70% of its free cash flow to shareholders this year. It intends to grow its base dividend, buyback shares, and pay variable dividends. Given its currently low valuation -- Devon trades at around an 11% free cash flow yield, making it more than 50% cheaper than the broader market indexes -- it will likely prioritize repurchases over variable dividends in the near term. It will use the other 30% to retire maturing debt and further strengthen its financial profile.
Meanwhile, the company is on the lookout for its next transformational merger. While all its rumored acquisition targets have since agreed to a deal with another suitor, plenty of potential merger partners remain. The right deal at the right price could further enhance its ability to generate free cash flow and pay dividends.
Using its cash to create shareholder value
Devon Energy has become a free cash flow machine since closing its transformational merger with WPX Energy. That has given it the money to pay dividends, repurchase shares, strengthen its balance sheet, and make acquisitions. The company is in an excellent position to continue growing shareholder value in the future, especially if it can capitalize on the current M&A wave in the oil patch to complete another transformational deal.
