With an almost 28% decline in 2024, Devon Energy (DVN 1.33%) is a stock that fell out of favor with the market. The sell-off has arguably been overdone, as the price of oil spent much of last year trading with a $70 per barrel handle and trades at almost $75 per barrel at the time of this writing. Meanwhile, Devon Energy strengthened its business through 2024, and the stock is now looking like a great value. Here are three reasons why.
A good value oil and gas stock
Devon's $5 billion deal to acquire Grayson Mill Energy raised some eyebrows. It's fair to say the stock has trended downward since its announcement in early July. It's challenging to know precisely why the market is concerned. Still, one possible reason is the acquisition of significant assets in the Williston Basin (Bakken) in North Dakota. In recent years, the more highly valued Permian region assets (where Devon's core Delaware Basin assets are) have grown oil output more successfully than the Bakken region. In addition, the market may be worried because Devon was using $80 per barrel to base the deal on.
But here's the thing: Based on its post-deal projections, Devon Energy is still an outstanding value. With the Grayson Mill deal now closed, management's preliminary 2025 outlook put it at a free-cash-flow (FCF) yield of 9% at a price of oil of $70 per barrel, 14% at $80 a barrel, and 5% at $60 a barrel, based on the then stock price of about $38.30.
However, interpolating those figures for the current stock price of $34.88 would put Devon at an FCF yield of 9.9% at a price of oil of $70 a barrel. That's a huge yield, and the FCF will give Devon's management plenty of opportunity to return cash to shareholders.
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Good progress in 2024
Moreover, the company has made good operational progress recently. Its investment in its core Delaware Basin assets has improved productivity by 20% and overall management expects production volumes of 800 thousand barrels of oil equivalent per day (mboed) in 2025 compared to an expected 730 mboed in 2024. The target of 800 mboed in 2025 is 5% above what management initially outlined in the Grayson Mill deal's announcement.
In addition, in early November, Devon's Chief Operating Officer Clay Gaspar told investors that "production from the acquired assets is expected to slightly exceed our initial expectations." He went on to argue that Devon would blow away the initial synergy targets for the deal with some early wins on sharing infrastructure and inventory.
Capital allocation policy
Having mentioned Devon's substantive FCF generation opportunity, it's time to examine its capital allocation more closely. Wall Street analysts expect $2.78 billion in FCF in 2025 (although that figure can vary dramatically based on energy prices). Given the stock's relatively low valuation, management has elected to prioritize share buybacks and ongoing debt repayment over its variable dividend.
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While that may disappoint some income-seeking investors, it makes long-term sense. Reducing debt lowers interest payments, and reducing the share count increases existing shareholders' claims on future cash flows and dividends from the company. Moreover, the ample cash flow leaves room to increase the variable dividend.
A stock to buy
Another possible reason for the decline in Devon's stock could be Grayson Mills' previous owners (a private equity company) selling down the $1.75 billion worth of stock they got as part of the deal.
Whether private equity is selling or disappointed dividend investors are bailing out, Devon Energy stock looks like a great value now. If the price of oil behaves, the stock has significant upside potential in 2025.
