Portfolio holding Devon Energy (DVN) reported mixed fiscal first-quarter results after the closing bell Monday.

Total revenue of $3.81 billion came up short versus expectations of $4.01 billion. Adjusted diluted earnings of $1.88 per share was better than the $1.76 per share the Street was looking for. The top line and the bottom line surged nearly 86% and over 300%, respectively, compared to the year-ago period, which saw oil and gas demand severely depressed by Covid lockdowns and mitigation measures around the world in the second year of the pandemic. Shares of Devon Energy rose 2.7% in after-hours trading.

Cash flow

Operating cash flow for the quarter of $1.84 billion was a bit shy versus the $1.99 billion expected. After accounting for all capital requirements, free cash flow of $1.3 billion came up short versus expectations of $1.38 billion. However, like revenue and EPS, both of these metrics also surged from last year’s Covid-depressed levels.

Capital allocation

While cash flow results may have been short of expectations, they were strong enough to allow Devon Energy to declare a new record high Q1 fixed-plus-variable dividend payout of $1.27 per share — up from $1 per share in the fourth quarter — payable on June 30, 2022. Based on Monday’s closing price of $58.35, this annualizes to an 8.71% yield.

Dividend payments are only one way that management returns capital shareholders, the other being share buybacks. On this front, management also upped the ante, expanding the repurchase program by 25% to $2 billion, up from the expansion to $1.6 billion announced in the fourth quarter. On a nearly $40 billion market cap, that amounts to about 5% of shares outstanding. Since the start of its repurchase program, Devon Energy has already returned $891 million to shareholders, gobbling up 3% of shares outstanding at an average price of $47 per share.

Capital discipline

At a higher level, the story at Devon Energy remains the same as management continues to emphasize capital discipline with a focus on moderating oil growth targets, margin expansion via operational scale and cost efficiencies, and above all a returns driven strategy that prioritizes free cash flow generation. This focus on capital efficiency is translating into a strong, investment-grade balance sheet, with management now targeting a net debt-to-EBITDAX (earnings before interest, tax, deprecation, amortization, and exploration expense) ratio of less than 0.2x by year-end 2022, down from the 0.5x level they guided for in the prior quarter.

Guidance

Looking ahead, the team said it will continue to prioritize free cash flow over volume growth. For the second quarter, management is targeting 585 to 604 MBoe/d (thousand barrels of crude oil equivalent), about inline with the 592 MBoe/d expected.

For fiscal year 2022, management issued the following guidance. Management raised the bar for free cash flow growth to roughly 75%, up from over 70% guided to in the prior quarter. Not quite the year-over-year double the Street was hoping for. But given it is only the first quarter, we wouldn’t be surprised to see this guide prove conservative, especially should energy prices hold at these levels.

Management reiterated total production of 570 to 600 MBoe/d, a tad short versus expectations of 590 MBoe/d at the midpoint, though not a huge miss. Again, the team is more concerned with returning cash to shareholders than they are production growth for the sake of growth. So the reiterating, rather than increasing, may actually be viewed favorably by investors. It’s also important to remember that when a team invests in more production, there is generally a long delay between when investments are made and when oil is actually produced. As a result, we think management is once again demonstrating discipline by focusing on shareholder returns and not getting sucked into the lure of high oil prices that may not even be available by the time oil is pulled from the ground.

Management reiterated capital investment in upstream, which is the exploration and production of crude oil and natural gas, at $1.9 billion to $2.2 billion.

Regarding the free cash flow target, this growth assumes $100 per barrel of West Texas Intermediate (WTI) crude prices, with Henry Hub & Natural Gas Liquids (NGL) realizations at 40% of WTI. Based on a roughly $40 billion market cap, this amounts to a free cash flow yield of 16%. The team also provided some sensitivity analysis, indicating that should WTI average $90, the yield will be closer to 14% and should it average $110 we would be looking at something closer to a 18% yield.

Bottom line

Pump it, print it, pay it: that was the plan when we initiated our position in Devon Energy back in January, and it remains the plan now. With this release, management once again made clear that their No. 1 priority is returning capital to shareholders.

Rather than chase currently high oil prices with aggressive investments in production, which won’t yield returns until well into the future when prices may be lower, management is focused on producing what they have at capacity, keeping production growth at “up to 5% annually,” printing returns on that production and paying us, the shareholders, via one of the most shareholder friendly capital return policies in the market.

From this quarter's results, we see no change to our investment thesis — and with oil prices sustaining at high levels, we continue to see more shareholder returns ahead.