This Yield Surged – but Is It Sustainable?

Devon Energy (NYSE: DVN) is an oil and gas producer that pays a big 9.7% yield. But is this Oklahoma City-based company’s dividend all hat and no cattle? Let’s find out.

Devon’s free cash flow has been rising since 2019, and in 2021, it spiked to $2.9 billion from $193 million the prior year. It’s expected to rocket higher this year to $6.8 billion. The leap in cash flow has been due mainly to acquisitions.

Will all of that free cash flow sustain the dividend?

Last year, Devon paid $2.4 billion in dividends while generating $2.9 billion in free cash flow. That gives us a payout ratio of 82%, which is a little high. I like to see payout ratios of 75% or lower to ensure that if things get tough for a year or two, the company can maintain its dividend.

For 2022, dividends paid are forecast to come in at $3.6 billion, or just 52% of this year’s projected free cash flow. So if free cash flow comes in anywhere close to estimates, it shouldn’t be an issue.

But if something goes wrong and free cash flow is light or stumbles next year, our dividend cut antennae will be vibrating.

Devon slashed the dividend in 2016, from $0.24 per share quarterly to $0.06. The company slowly raised the dividend over the following years, also paying special dividends that are not reflected in this chart. With its improved cash flow situation, the company appears to now feel confident enough to pay a much higher regular quarterly dividend.

As it stands, there doesn’t seem to be much worry regarding a dividend cut. But should oil prices take a dive (which they are known to do) or should Devon’s free cash flow dry up for some other reason, watch out. The company has shown a willingness to lower the dividend in the recent past, so investors should be aware that management could do so again.

Dividend Safety Rating: C

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Good investing,

Marc