Devon Energy’s strong quarter came with blockbuster return of cash to shareholders

Club holding Devon Energy (DVN) reported strong fiscal second-quarter results Monday. Total revenue of $5.63 billion crushed expectations of $4.21 billion. Adjusted diluted earnings of $2.59 per share were better than the $2.37 the Street was looking for. Devon Energy is scheduled to host its post-earnings conference call on Tuesday at 11 a.m. ET. As a result, we won’t have much in terms of management commentary until then. We’ll follow up with any important information after the call. Bottom line We believe this strong quarter speaks to an adherence to the strategy we found so attractive when we took our position in January — prioritizing cash returns to shareholders over energy production growth. While the average realized oil equivalent price was a tad below expectations, it was nonetheless up significantly on both a sequential and annual basis. More importantly both operating cash flow and free cash flow — the latter of which is key to cash returns to shareholders — came in well above expectations. Cash flow Operating cash flow for the quarter of $2.68 billion was better than the $2.38 billion expected. After accounting for all capital requirements, free cash flow of $2.11 billion came well above expectations of $1.79 billion. According to Devon’s earnings press release, this represents the highest quarterly amount of free cash flow in the company’s 51-year history. Capital allocation As members know, we pay close attention to cash flow metrics because at the end of the day, the core of investment thesis (and this applies to all of our upstream energy names (Devon, Pioneer and Coterra ) is that these companies will generate significant cash flows and then turn around and distribute that cash to shareholders via dividends and buybacks. To this point, the strong cash flow realized in the second quarter allowed management to announce a 22% raise to the company’s fixed +variable dividend payout, to $1.55 per share. That’s up from $1.27 previously. At a $62 share price for DVN stock, that annualizes a 10% payout. Dividend payments are only one way that management returns capital shareholders, the other being share buybacks. On this front, management noted that since the inception of Devon’s $2 billion share repurchase authorization, the team has already returned $1.2 billion to shareholders, retiring 4% of shares outstanding at an average price of $50 per share. Capital discipline At a high level, in providing the team’s thoughts as they look out to 2023, we were pleased to see them reiterate that there will be no change in their strategic plan and that the focus remains on: Per-share financial growth Planning for steady and consistent activity Prioritizing free cash flow generation Generating market-leading cash returns As a result of this financial discipline, Devon exited the quarter with a net debt-to-EBITDAX (earnings before interest, tax, deprecation, amortization, and exploration expense) ratio of 0.4x (on a trailing 12-months basis), down from 0.8x at the end of 2021. Guidance Looking ahead, for the third quarter, (current quarter) management is targeting production of 593 to 613 MBoe/d (thousand barrels of crude oil equivalent), below the 697 MBoe/d expected. For fiscal year 2022, management updated guidance as follows: Management also raised their production forecast by 3% to a range of 600 to 610 MBoe/d, above expectations of 599 MBoe/d noting that “the improved volume outlook is due to better-than-expected well performance year-to-date and the impact from a bolt-on acquisition in the Williston Basin,” a resources-rich body of land that stretches across Montana, North Dakota, South Dakota, and Canada. Management also increased their forecast of capital investment in upstream, which is the exploration and production of crude oil and natural gas, to a range of $2.2 billion to $2.4 billion noting that the “updated outlook incorporates $100 million of incremental capital related to the acquisition in the Williston Basin and the impact of inflationary cost pressures.” This investment is expected to be fully funded by operating cash flow, which the team anticipates will come in at nearly $9 billion for the full year. Regarding the cash flow, the team continues to anticipate a free cash flow yield of 16% based on $95 per barrel WTI (West Texas Intermediate crude) with the intention of returning 75% of that free cash flow to dividends and buybacks. The team also once again provided some sensitivity analysis, indicating that should WTI average $85, the yield will be closer to 15% and should it average $105 we would be looking at something closer to a 17% yield. WTI settled in New York trading Monday around $94 per barrel. Production and pricing Taking a look at quarterly production, total oil equivalent production came in at 616 MBoe/d, above expectations of 595.7 MBoe/d. The makeup of this production was as follows: Oil: 300 vs. 294.4 expected MBbls/d (one thousand standard barrels of 42 U.S. gallons per day) NGL: 156 vs. 147.3 expected MBbls/d Gas: 961 vs. 928.0 expected MMcf/d (one million cubic feet per day) As for pricing (including cash settlements, think hedging activity such as selling futures contracts to lock in prices in future periods and therefore operate with increased certainty), on a total oil equivalent basis, Devon realized a price of $64.70 per barrel of oil equivalent (Boe). That result comes up short versus expectations of $66.80 per Boe. However, it represents a significant increase versus the $54.75 per Boe realized in the first quarter and far exceeds the $34.64 per Boe realized in the year ago period. The makeup of this price realization was as follows: Oil: $95.80 vs. $91.30 expected per barrel NGLs: $40.28 vs. $40.70 expected per barrel Gas: $5.06 vs. $4.80 expected per Mcf (one thousand cubic feet) Before accounting for the hedges, on a total oil equivalent basis, Devon realized a price of $73.13 per Boe, above expectations of $70.50. The breakdown excluding hedging was as follows: Oil: $108.93 vs. $104.70 expected per barrel NGLs: $40.28 vs. $42.80 expected per barrel Gas: $6.37 vs. $5.70 expected per Mcf (Jim Cramer’s Charitable Trust is long DVN, PXD and CTRA. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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