Devon Energy (DVN) cut its variable dividend with its Q2 results announced on Aug. 1. The variable portion of the dividend, paid out as 50% of adj. free cash flow, was cut by 44%, but the overall dividend, including its fixed dividend, fell by 31.9% from 72 cents to 49 cents. However, this still leaves DVN stock with an attractive 3.87% annualized yield.
This can be seen by multiplying the quarterly 49 cents dividend by 4 and then dividing it by today's $50.62 price (i.e., $1.96/$50.62). Moreover, given that oil and gas prices are stabilizing here and its production is rising, Devon Energy's free cash flow should stay strong going forward
Variable and Fixed Dividend
For example, the company reported that its excess free cash flow (FCF), after paying out the fixed dividend, was $381 million. Given that it pays out 50% of this as a variable dividend, this allowed it to pay out $186 million.
So, since there are now 641 million shares outstanding the variable dividend works out to 29 cents, down 44% from the 52 cents quarterly dividend last quarter. Nevertheless, since Devon also pays out 20 cents on a fixed quarterly basis (i.e., $128 million), the total quarterly dividend is 49 cents.
The company's CEO and President, Rick Muncrief, said that this was the 12th consecutive quarter that the company had generated positive FCF. Moreover, combined with its $462 million in fixed and variable dividends (at the 72 cents variable rate), Devon Energy spent $228 million on share buybacks.
That means that its total shareholder returns were $690 million. But going forward, given that the cost of the dividend will be lower at just $314 million (i.e., $128 million fixed plus $186 million variable dividends), plus $228 million in share buybacks, the total cost of shareholder returns will be lower at $542 million.
That 21% reduction in payments for shareholders (i.e. $542 million vs. $690 million) should make the dividend and buybacks more sustainable.
This is why shareholders can expect that today's 3.87% dividend makes the stock very attractive in the long run.
Shorting OTM Puts for Income
One way to play this for additional income is to sell short near-term expiration put options that have strike prices that are out-of-the-money (OTM). For example, we discussed a similar play to short the $43.00 strike price expiring on July 21, in our Barchart article, “Despite Devon Energy's Dividend Cut, Its High Yield Still Makes It A Buy.”
Since DVN stock closed at $52.26 on July 21, those puts expired worthless, which makes the trade a success. That means the traders who collected the 37 cents when they shorted those puts, kept that income and had no obligation to buy the stock at $43.00.
Similarly, today the $47.00 strike price puts expiring Sept. 1, trade for 33 cents at the midpoint. That means that the short-seller of these puts collects 0.70% with just 3 weeks before expiration.
This works out to an annualized income rate of 11.9%, if this trade can be repeated every 3 weeks or 17 times a year.
For example, assuming the trader secures $4,300 in cash and/or margin with their brokerage firm, the trader can then enter an order to “Sell to Open” 1 put contract at the $47.00 strike price. The account will then immediately receive $33.00, working out to a 0.7% yield on investment.
This $47.00 strike price is over 7.0% below today's price. That gives the short-put trader a buffer in case DVN stock falls further. However, you can see in the table above that the $48.00 strike price has a higher premium of 50 cents, with just a 5.4% width below today's price. That gives a slightly higher yield of 1.04% or over 17.7% annually if repeated every 3 weeks.
In other words, DVN stock offers investors a high dividend yield, and options investors can also generate very good income with out-of-the-money short-put options plays.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
