Dividend stocks are everywhere, but many just down right stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low, it's not even worth the paper your dividend check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today, and one day each week for the rest of the year, we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say that these stocks don't share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. Check out last week's selection.
This week, we'll turn our attention to domestic oil and gas exploration and production (E&P) company, Devon Energy (NYSE:DVN).
Feeling a bit gassy
That’s right, I'm featuring a company with large natural gas deposits and a current 1.5% yield as a great dividend play you can buy right now. Go on, get all the head-scratching and jokes out of the way now, because you might be climbing over each other to dig deeper into Devon by the time I'm done.
As you are probably well aware, the biggest challenge to Devon Energy and much of the natural gas-heavy E&P drillers has been the volatile prices of the commodities they produce. Very large onshore shale finds over the past decade have dramatically increased natural gas surpluses and -- for lack of a better word -- tanked nat-gas spot prices. The end result is that companies that were heavily reliant on natural gas for their production have had to shift gears and focus on liquid fuels in order to prosper.
For some natural gas companies, this wasn't an easy transition. Chesapeake Energy (NYSE:CHK), for instance, didn't even have enough cash on hand to cover its capital expenditures and operating expenses for 2013, which necessitated the sale of $6.9 billion worth of Permian Basin assets to Chevron (NYSE:CVX) and Royal Dutch Shell. For Chesapeake, which really didn't have much choice, it gives the company breathing room, while a behemoth like Chevron was able to pick up natural gas-heavy assets for an incredibly competitive price.
EnCana (NYSE:ECA), the Canadian equivalent to Chesapeake, has had it a bit easier, although it essentially took the same route as Chesapeake in terms of a vastly reduced dry gas capital expenditure budget and asset sales in order to boost its cash on hand. EnCana sold a 40% stake in undeveloped assets in British Columbia to Mitsubishi early last year, netting $2.9 billion.
For Devon Energy, the process has been considerably easier for a number of reasons.
The Devon advantage
First and foremost, Devon is a mastermind when it comes to striking beneficial joint ventures. No E&P company likes giving up working interests in lucrative fields, but when it comes down to it, Devon can use the upfront cash payments to pay down a good chunk of its operating and drilling expenses. This is what it did recently when it received $1.4 billion from Sumitomo, which, in exchange for the payment, received a 30% working interest in Devon's Cline Shale and Midland-Wolfcamp Shale acreage.
Second, Devon has made a nearly seamless transition toward higher liquids production. Although this doesn't set Devon apart from the trend that we've seen throughout the sector, unlike some E&P companies, Devon does have the oil reserves to support increased production. In 2012, Devon boosted its oil production by 13%, relying on greater efficiency, the addition of wells in the Permian Basin -- which boosted oil production by a whopping 31% -- and cash from its joint ventures to drive production growth. Devon also boosted its oil reserves by 13% and projects a 12-year lifespan based on existing proven reserves.
Another prominent factor that should keep Devon on investors’ radars is its hedging strategy, which keeps cash flow and profits relatively predictable. PDC Energy (NASDAQ:PDCE) is a great example. PDC has been actively moving toward a portfolio dominated by liquids but has employed various commodity hedging strategies to minimize its exposure to weak natural gas prices. The end result was a $32 million gain in 2012 for PDC. In similar fashion, Devon has hedged 115,000 barrels per day of oil production (keep in mind it produced 151,000 per day in 2012) with close to half weighted at $101 per barrel and the rest at a variable rate between $90 and $113 per barrel. Devon also has 60% of its natural gas hedged for 2013.
Show me the money, Devon
Ultimately, what makes Devon particularly attractive is its valuation relative to its peers and its rapidly growing dividend.
Compared with both Chesapeake Energy and EnCana, Devon is valued at a lower enterprise value/EBITDA ratio while trading at a comparable price-to-cash-flow to both companies. Devon certainly isn’t strapped for cash, although I have to admit that a good portion of its cash on hand is from overseas asset sales that could face heavy taxation upon repatriation. Still, Devon's operating cash flow has resulted in share buybacks and some of the most consistent dividend growth in the sector.
Devon Energy has boosted its dividend eight times since 2004. Although there's no rhyme or reason to the dividend increases, Devon's announced 10% dividend boost to $0.22 from $0.20 this month now means that shareholders have seen their quarterly stipend rise by 340% since 2004. To put that another way, Devon has increased its dividend by an average of 24% since 2004. The best part about Devon's dividend is that it’s completely sustainable -- its payout ratio is just 24% of this year's projected EPS.
Devon really is one of the most balanced E&P companies in the oil sector. Even though it's cut back significantly on its natural gas production, it has a more than ample supply to drill for when President Obama's energy-independence initiatives drive natural gas production and prices higher. In the meantime, oil production and reserves are increasing, and Devon is doing what it can to reward shareholders for taking the long-term journey. Devon is a phenomenally well-run company, and its payout is definitely something income investors can count on for quite a long time.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on Motley Fool CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool owns shares of Devon Energy, has options on Chesapeake Energy, and recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.