The energy sector is up big so far in 2024, largely thanks to an 11% surge in the price per barrel of Brent crude oil (the international benchmark). Investors wondering how to approach the sector have come to the right place. There's always the balanced approach of investing in an integrated major like ExxonMobil or Chevron. Majors are good foundational choices if you're looking at where to start in oil and gas.
But the companies that directly benefit from higher oil prices the most are those that are solely in the business of producing oil and gas, known as exploration and production (E&P) companies. ConocoPhillips (COP 0.47%), Devon Energy (DVN +0.30%), and Diamondback Energy (FANG +1.54%) are three E&Ps worth considering now. While they are similar, they also have some key differences.
Here's a breakdown of each company to help you decide which dividend stock might be best for you.
Image source: Getty Images.
1. ConocoPhillips
ConocoPhillips is a behemoth in the E&P space with a market capitalization of nearly $150 billion. It isn't as boom or bust as other E&Ps. Its debt-to-equity ratio spiked above 0.40 in 2020 -- which isn't terribly high -- and then quickly fell as the industry recovered. By comparison, other E&Ps saw their leverage surge to alarming levels.
COP Financial Debt to Equity (Quarterly) data by YCharts
Other metrics that are worth a look are the company's capital expenditures (capex) as a ratio of its revenue, as well as its return on capital employed (ROCE). ROCE helps measure a company's ability to profit from the capital it invests in the business.
COP CAPEX to Revenue (Annual) data by YCharts
In the chart, you can see that ConocoPhillips has done an excellent job keeping its capex-to-revenue ratio under 0.30 since the downturn of 2015. Its ROCE has increased during the current growth cycle thanks to high oil prices, but it is still keeping a tight lid on spending.
ConocoPhillips' 10-year plan focuses on breaking even at a U.S. benchmark West Texas Intermediate (WTI) price per barrel of just $35, and basing its investments around a mid-cycle WTI price of $60 per barrel. For context, WTI is currently around $83 per barrel.
ConocoPhillips pays an ordinary and a variable dividend. The ordinary dividend has steadily climbed and is now $0.58 per share per quarter. However, the most recent variable dividend was only $0.20 per share, a sizable decline from $0.60 per share in the prior payment.
ConocoPhillips uses the variable dividend to directly reward shareholders when it earns outsized free cash flows. The variable dividend can be quite sizable when oil prices are high. In 2022, the company paid $1.89 per share in ordinary dividends but $3.10 per share in variable dividends. Investors shouldn't expect the company's variable dividend to be as high this year. But at a minimum, the stock should yield around 3%, even assuming moderate variable dividends.
All told, ConocoPhillips has stayed even-keeled no matter the cycle and doesn't overspend when oil prices are high.
NYSE: COP
Key Data Points
2. Devon Energy
Devon Energy mainly operates out of the Delaware Basin, Eagle Fold, Anadarko Basin, and other oil-rich areas around the Rocky Mountains. But over 60% of 2024 estimated capital spending is expected to go toward the Delaware Basin.
Devon is more concentrated on the lower 48 states than ConocoPhillips. By comparison, a little over half of ConcoPhillips' Q4 adjusted earnings came from the lower 48, illustrating the importance of its international exposure.
Devon is also far smaller, with a market capitalization around one-fifth the size of Conoco. Devon also pays a variable dividend, but it may pay a far lower one going forward for the same reasons as Conoco -- oil prices are lower than in 2022.
At the time of the company's Q4 2023 earnings call in late February, Devon Energy stock was trading around a two-year low despite Devon having paid a whopping $5.17 per share in dividends in 2022 and $2.87 in 2023. Management wasn't exactly thrilled with the market's lack of interest in the stock despite the value it had returned to shareholders. Devon CEO Rick Muncrief said on the most recent earnings call:
Our business is set to deliver a free cash flow yield that is up to three times that offered by the broader markets. With this free cash flow, we are targeting a cash return payout of around 70%, while earmarking the remainder to further strengthen our balance sheet. ... Given that the equity market is heavily discounting valuations in the energy sector, it's an easy decision to prioritize a buyback over the variable dividend to capture the incredible value that Devon offers at these historically low valuations.
Even with the stock up 14% in the past month, there's a good chance Devon will pay far lower dividends this year than in 2022 or 2023. And since Devon hasn't made a big acquisition, buying back stock could be a good use of capital. Investors who agree with Devon's decision to allocate its free cash flow (FCF) toward buybacks over variable dividends may want to buy the stock now.
3. Diamondback Energy
Like Devon, Diamondback Energy returns the majority of its FCF to shareholders -- around 75% in Q4 2023. $162 million went to the base dividend, $392 million went to the variable dividend, and $129 million was used on stock buybacks.
In terms of concentration, Diamondback is in a league of its own. It is almost exclusively focused on the Permian Basin. Unlike ConocoPhillips and Devon, Diamondback has been active in the merger and acquisition (M&A) department.
On Feb. 12, it announced a merger with Endeavor Energy Resources, a privately held pure-play E&P, to create one of the largest independent producers in the Permian. It's an ultra-aggressive move that positions Diamondback to win big from higher oil prices, but also makes it more vulnerable to a downturn.
Therefore, it makes sense that Diamondback is up significantly more than ConocoPhillips, Devon Energy, and the broader energy sector so far this year.
It's unclear how the merger will affect Diamondback's next few variable dividends. The company has leaned on dividends more than buybacks, and it probably won't be doing any significant buybacks anytime soon given the merger with Endeavor. But we'll just have to wait and see how the company wants to allocate capital post-merger.
Either way, Diamondback stands out as the highest-risk and highest-potential-reward bet on this list, and a stock that should considered if you are very optimistic about oil prices remaining high over the long-term.
Three ways to ride oil prices higher
ConocoPhillips, Devon Energy, and Diamondback Energy are all E&Ps that pay ordinary and variable dividends. But each company has a significantly different production portfolio, approach to M&A, capital return strategy, and balance sheet. All three stocks could be worth buying now, but the best pick depends on your risk tolerance and investment objectives.
