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A Big Downgrade for Devon Energy’s Dividend Safety

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Devon Energy (NYSE: DVN) is popular with investors because of its big yield. Depending on how you calculate it, the yield is anywhere from 1.4% to 9%.

Let me explain…

Like several oil and gas companies these days, Devon Energy pays a variable dividend. This is done so that in good times it can pay out more cash to shareholders and in not-so-good times it can pay less without it being considered a “cut.”

Devon’s fixed quarterly dividend is $0.20 per share, up from $0.18 the previous quarter. But the rest of the dividend can be all over the place depending on the company’s performance.

Next week, shareholders will receive a $0.69 dividend on top of the $0.20. Last quarter, the variable portion of the dividend was $1.17. It was $1.37 the quarter before that.

The good news is that free cash flow is expected to rise sharply for Devon Energy this year, from $3.4 billion a year ago to $4.5 billion. That should bring down the payout ratio, which was way too high in 2022.

Last year, management paid out 99.1% of its free cash flow in dividends. My comfort level is 75% or lower. A 99% payout ratio means that if free cash flow stumbles even a little, the company has to either reduce the dividend or pay it out of cash (or, God forbid, borrow money to pay it).

Even before the variable dividend policy went into effect in mid-2022, Devon had slashed its payout to shareholders in 2016, when it lowered the dividend from $0.24 per share to $0.06.

So management is not afraid of the nuclear option. Add in the stated variability of the dividend, and it is clear you cannot count on the dividend remaining the same.

With free cash flow expected to soar this year, things may not be bleak. But with a variable dividend, you can never rely on the same payout year after year or quarter after quarter.

Dividend Safety Rating: F

Dividend Grade Guide

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Good investing,

Marc

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