4 Reasons to Buy This Dividend Stock Today

Devon Energy is an attractive stock to buy now for several reasons. For starters, the oil and gas producer has refocused its portfolio to become among the lowest-cost producers in the industry. The company also has carved out a narrow economic moat thanks to cost advantages, which suggests that it will outearn its cost of capital over the next decade. Also, Devon’s capital return framework prioritizes returning cash to shareholders through both fixed and variable dividends, as well as buybacks when the stock is undervalued. And lastly, the shares are trading 20% below our $48 fair value estimate, suggesting there’s upside price potential. In fact, Devon Energy is among Morningstar chief US market strategist Dave Sekera’s 5 Stocks to Buy With Solid Fundamentals and Upside Potential.

Devon Energy is among the lowest-cost oil and gas producers on the US shale cost curve. Its portfolio is buoyed by its presence in the Delaware, which supplies some of the lowest breakeven costs among US basins. About two thirds of Devon’s production is tied to this premier asset, which helps the company command favorable well production relative to peers. But Devon is more than just a single basin play; it boasts a meaningful presence in four of the top five US shale basins by lowest breakeven costs. Exposure to high-quality assets with a near 17-year remaining inventory life, coupled with operational improvements from initiatives like longer laterals, should allow Devon to enjoy modest production growth. We expect production gains will come at increasingly attractive drilling and completion costs.

Key Morningstar Metrics for Devon Energy

• Fair Value Estimate: $48
• Star Rating: 4 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: Medium

Economic Moat Rating

We think Devon has a narrow economic moat because of cost advantages. Hydrocarbons are commodity products and therefore don’t exhibit pricing power, switching costs, or other moat sources that depend on meaningful differentiation or a market niche. However, we think low-cost producers, or those that maintain production costs well below the industry’s long-term marginal cost, can command an advantage over their higher-cost counterparts. Devon’s breakeven oil price of just under $36.50 a barrel falls well below our estimated marginal cost of production at $60/bbl Brent and also below the independent group average of over $39/bbl. Devon maintains its cost advantage primarily through access to low-cost resources with intrinsically low extraction costs.

Read more about Devon’s moat rating.

Fair Value Estimate for Devon Stock

Our $48 fair value estimate corresponds to enterprise value/EBITDA multiples of 4.2 times for 2024 and 3.8 times for 2025. Our production forecast for 2024 is 756 thousand barrels of oil equivalent per day, which drives 2024 EBITDA of about $8.7 billion. We expect free cash flow will reach $4.1 billion in the same period. Our 2025 estimates are production of approximately 842 mboe/d, EBITDA of $9.7 billion, and free cash flow of $4.5 billion. We assume oil (West Texas Intermediate) prices in 2024 and 2025 will average $78 and $72 a barrel, respectively. In the same periods, we expect natural gas (Henry Hub) prices will average $2.36 and $3.36 per thousand cubic feet. We define terminal prices by our long-term midcycle price estimates (currently $60/bbl Brent, $55/bbl WTI, and $3.30/mcf natural gas).

Read more about Devon’s fair value estimate.

Risk and Uncertainty

Like most exploration and production firms, Devon faces significant risk related to volatile oil and gas markets. A deteriorating outlook for oil and natural gas prices would pressure Devon’s profitability, reduce cash flows, and drive up financial leverage. An increase to federal taxes, or a revocation of the intangible drilling deduction that US firms enjoy, could also affect profitability. Devon’s portfolio includes prospective acreage leased on federal land in New Mexico, making it vulnerable to the permit ban that President Joe Biden’s administration once threatened. Devon also faces material environmental, social, and governance risks via greenhouse gas emissions (both from extraction operations and downstream consumption) and other emissions, effluents, and waste (primarily oil spills).

Read more about Devon’s risk and uncertainty.

Devon Bulls Say

• Devon enjoys ideally located acreage in core portions of the basins it operates in. Attractive acreage translates to above-average well performance and peer-leading supply costs.
• Devon’s shareholder-friendly capital allocation plan opens the door for substantial returns to shareholders via a base dividend, a variable dividend, and opportunistic buybacks.
• By capping growth at 5% annually, Devon avoids the risk of overspending during upcycles, a common fault of many upstream firms.

Devon Bears Say

• After incorporating sunk costs from leaseholds, acquisitions, exploration, and infrastructure, Devon’s capital base inflates to a level that could threaten excess returns.
• Devon’s profitability in the Permian can’t be matched in other parts of its portfolio.
• Production growth could periodically outpace midstream capacity additions in the Permian, creating bottlenecks like Devon faced in the first half of 2023.

This article was compiled by Susan Dziubinski and Sylvia Hauser.