Here’s how Devon Energy can become a very high dividend yielding stock again

Investors looking for income should not underestimate the potential for significant returns on capital at Devon Energy (DVN -0.49%). Stock dividends aren’t quite at the level of recent years, but neither is the stock price. What’s more, its current trailing dividend yield of 4.5% is nothing to be sniffed at, and there are strong reasons to believe its dividend could grow significantly in 2025. Here’s why Devon Energy is a great stock for investors focused on high dividend yield.

An oil and gas stock that grows cash flow and dividends

This is an oil and gas exploration and production company, so if you are uncomfortable with the outlook for energy prices or don’t want to include energy exposure in your portfolio, read no further.

That said, many investors seek exposure to energy prices or are agnostic about their direction. In this case, Devon’s combination of very high cash flow generation, strategic acquisition of Grayson Mill Energy’s Williston Basin (Bakken) business for $5 billion, and return on capital strategy are compelling reasons to buy the stock.

Devon Energy dividend history

The following chart demonstrates how Devon Energy has cut its dividend from 2022. Dividends (a combination of fixed and variable payments) totaled $5.06 in 2022. Based on the current price of $44.65 per share, this would represent a extraordinary dividend yield of 11.4%.

In contrast, the current final dividend payout of $2 per share yields 4.5%.

Data source: Devon Energy presentations. Chart by author.

However, it is important not to emphasize where a stock has been rather than where it might go. The reality is that oil and gas prices tend to be volatile and will remain so as long as there is a market. In particular, the drop in the cost of gas has negatively impacted Devon Energy’s earnings, cash flow and ultimately dividends through 2023.

WTI Crude Oil Spot Price data by YCharts.

However, current energy prices and Devon’s share price support the case that its dividend will grow significantly in 2025.

Why Devon Energy is set to make big dividends again

First, Devon’s free cash flow (FCF) yield is very high at the current share price. Management helpfully provides a rough estimate of its FCF yield at a range of oil prices per barrel in 2024. The forecast used market capitalization on August 2, when the stock closed the day at $42.79.

Using these estimates and Devon’s updated share price yields a rough estimate of an FCF yield of 8.6% at $70 per barrel, 10.5% at $80 per barrel and 12.5% ​​at $90 per barrel.

Image source: Getty Images.

Second, these estimates do not include the acquisition that will close in the third quarter of 2024. Devon expects its full-year production volume to be 677,000 barrels of oil equivalent per day (BOE) to 688,000 barrels of oil per day in 2024 and the addition of the Acquisition will add 100,000 BOE in 2025. This is a nearly 15% addition to production and management believes it will add 15% to FCF generation in 2025 as well. It will be “accretive to share the capabilities of redemption and payment of dividends”.

Finally, the company’s capital allocation policy calls for 70% of its free cash flow (FCF) to be allocated to returning cash through share repurchases, a fixed quarterly dividend (currently $0.22) and a variable dividend.

Given the low share price, management has prioritized share buybacks in 2024. Devon spent $461 million on share buybacks in the first half, compared to $281 million on the fixed dividend and just $220 million on the variable dividend.

Image source: Getty Images.

Devon Energy’s dividend could grow significantly

Overall, provided energy prices remain stable, Devon’s increased production will translate into significantly improved FCF. For example, assuming an oil price of $70 per barrel in 2024 and the current price, Devon’s FCF yield could be 8.6%. Allocating 70% of FCF to cash earnings, in the form of dividends only, could produce a 6% yield.

And 15% FCF growth in 2025, all things being equal, could mean a dividend yield of 6.9%, and even more if oil prices are above $70 in 2025.