(Bloomberg) -- Oil is having a good year. Devon Energy Corp. is having a much better one.
The Oklahoma oil and gas exploration and production company is the best performing stock in the S&P 500 Index this year. Its 168% surge handily beat the 45% gain in West Texas Intermediate crude futures, not to mention the 24% rise in the S&P 500 and the 49% jump in the S&P 500 Energy sector, which is the top group in the equity benchmark for 2021 after being the worst last year.
Obviously, higher oil prices helped drive energy companies’ gains during the skittish global rebound from the Covid-19 pandemic. But what sets Devon apart from its peers, according to analysts, is a determination to return free cash flow to investors through a clear, fixed-plus-variable dividend framework for its capital returns.
“What we can’t control is commodity prices,” CEO Rick Muncrief said in an interview. “So we did have some tailwinds there, which actually gave us some uplift on the amount of free cash flow that you’re generating, which drives those really big dividend payments.”
It’s a strategy that clearly appeals to Wall Street.
“Devon has been a leader in the new paradigm for E&P, which is now a low-growth, free cash flow paradigm going forward,” Barclays analyst Jeanine Wai said.
The transformation started on Sept. 28, 2020, when Devon announced a merger with WPX Energy Inc., where Muncrief was running the show. Part of the plan for the combined company was to start a fixed-plus-variable dividend. Prior to that, Devon was down 66% on the year and was one of the S&P 500’s worst performers.
“It was primarily supply-and-demand concerns” that weighed on the stock, Muncrief said. “We were in the throes of the pandemic.”
Since then, the shares are up more than 358% and hitting levels last seen in 2018. The CEO thinks the company’s performance this year represents a rebound from the pandemic’s trading trough as well as the beginning of a new trajectory.
“With the discipline I’m seeing in the industry, I think we’re going to see multiples expand, which will help us,” Muncrief said.
Cash Return
Devon isn’t alone in seeing its shares soar. Energy stocks have rallied this year as oil prices have climbed with loosening Covid-19 restrictions creating demand and OPEC+ keeping output restrained.
Exploration and production companies historically have responded to swings in crude by increasing activity as prices went up and trimming back as they went down, Wells Fargo analyst Nitin Kumar said. But Devon’s fixed-plus-variable model gives it a balance of consistency and flexibility.
“They allowed that excess windfall from the commodity price to flow to the shareholders,” Kumar said. Instead of the cash flow from higher commodity prices being used to chase production growth, which in turn adds supply to the market that could weigh on the commodity prices, it goes to creating value for shareholders.
Wall Street has taken to the company, with 27 out of 32 analysts covering the stock rating it a “buy,” according to data compiled by Bloomberg. Their average 12-month price target implies about a 15% premium over Wednesday’s closing price.
“It’s pretty easy to figure out what we think is going to be coming straight back to the shareholders,” Barclays’s Wai said. “So we’re not surprised that it has performed so well, given their transparency on returning the cash and the quality of their inventory.”
The company has authorized a billion-dollar stock buyback program for next year, and its latest dividend announcement was $0.84 per share for the third quarter. Devon will evaluate the fixed element of the dividend in the first quarter of each year to determine whether to change it, Muncrief said.
“We don’t want to be a one-year wonder,” Muncrief said. “We want to show people that we’re a great long term investment.”