With crude oil prices around $75 a barrel, this high-yielding oil stock is an incredible bargain

Crude oil prices have risen quite a bit this year. They were recently around $75 a barrel, which is about 5% higher than they started the year. That’s a great price for most oil companies, which can generate a lot of cash at that level.

This is certainly the case Devon Energy (DVN -0.49%). It can produce free cash flow at the current price point. Despite this fact, oil stock trading at a bottom-of-the-barrel valuation (even more so after factoring in some very intense buying, working to close). Because of that, it’s an incredible deal these days for those looking for a value play in the oil zone. It also offers an attractive income stream (4% dividend yield in term on the most recent combined payment).

A slot machine with free cash flow

Devon Energy has worked tirelessly over the years to build a low-cost, US-focused oil and gas producer. This strategy has paid dividends in recent years. Devon has become one of the largest onshore producers in the country with a very low cost resource base. Its main jewel is the Delaware Basin, which has a breakeven point of around $40 per barrel.

Devon’s low costs allow it to generate a lot of cash. It generated free cash flow of $587 million during the second quarter. This was 80% above last year’s level, fueled by its rising production, efficient capital spending and improving commodity prices. Devon returned $532 million of that money to investors through share buybacks ($256 million), fixed base dividends ($138 million) and variable dividends ($138 million).

The company’s strong free cash flow he has it trading at a bottom-of-the-barrel valuation. Devon is trading at a free cash flow yield of about 10% based on its 2024 forecast of $75 oil. It is about three times larger than Nasdaqhis 3% free cash flow yield and more than double S&P 500his yield 4%. A higher free cash flow yield implies a cheaper valuation. That discount is why Devon’s dividend yield is about 4%, compared to a yield of 1.3% for the S&P 500 and 0.8% for the Nasdaq.

It gets even cheaper

Devon Energy recently took a major step to improve its ability to generate free cash flow. Agreed to buy Grayson Mill Energy for $5 billion. The transaction will be immediately accretive to earnings, cash flow and free cash flow. That’s because it’s buying Grayson Mill at a 15% free cash yield (assuming $80 oil).

The company expects Grayson Mill to grow its cash flow per share by about 10% in the first year, while improving free cash flow by 15%. Because of this, Devon will trade at an even cheaper valuation once it closes on that highly profitable deal.

Cheap dirt and do something about it

Devon Energy strongly believes its shares trade at an attractive valuation. This led the company to change its capital allocation strategy this year. It de-emphasized its variable dividend in favor of buying back more shares. Almost half of its capital return in the second quarter was share buybacks, while the variable dividend accounted for about a quarter of its return. That’s down from its original plan to use up to half of its excess free cash flow to pay variable dividends.

The oil company intends to keep buying back stock hand over fist following the Grayson Mill agreement. It expanded its share buyback program by 67% to $5 billion by mid-2026. This is on top of the $2.7 billion of shares it has bought back since the program launched at the end of 2021. In addition to the increase in buybacks following the Grayson Mill deal, Devon expects the acquisition it will be increased upon payment of dividends in 2025 and thereafter.

An attractive oil stock

Devon Energy is an incredible business these daysgiven the cash it can produce at current oil prices. In the meantime, it will be even cheaper once it closes on the Grayson Mill Energy acquisition. This deal will give it more fuel to buy back its cheap stock and pay dividends. Add it all up and Devon is a compelling option for those looking for oilfield income and growth potential.