After striking out several times, Devon Energy finally sealed a deal to increase its scale.
The oil industry has been in the midst of a massive consolidation wave sparked by Exxon‘s acquisition of Pioneer Natural Resources. Since then, most large oil companies have agreed to acquire a smaller rival to enhance their scale and ability to generate free cash flow.
Devon Energy (DVN -0.99%) has been trying to participate in the merger wave. Until recently, it had struck out several times as its targets agreed to deals with another rival.
However, Devon has finally secured a needle-moving acquisition. Here’s a look at the deal and whether it makes the oil stock a buy.
Drilling down into Devon’s deal
Devon Energy has agreed to buy Grayson Mill Energy’s Williston Basin business for $5 billion. It’s paying $3.25 billion in cash and $1.75 billion in stock. Devon Energy will fund the cash component with its strong balance sheet, which includes using cash on hand and issuing additional debt.
The acquisition will transform Devon’s operations in the Williston Basin of North Dakota. It will add 307,000 net acres to Devon’s position, increasing its total in the region to 430,000.
Meanwhile, it will triple Devon’s production in the region, adding 100,000 barrels of oil equivalent per day (BOE/d) to boost its total to 150,000 BOE/d. That will vault the Williston Basin to the company’s second-largest operating area behind the Delaware Basin (437,000 BOE/d) and more than double the output of the company’s next largest region. The deal will also expand the company’s Williston drilling inventory, which will last about a decade.
Devon Energy expects that the acquisition will be immediately accretive to its key financial metrics on a per-share basis, including earnings, cash flow, and free cash flow. It’s paying about a 15% free cash flow yield for Grayson Mill, assuming an average oil price of around $80 a barrel (a little below the recent price point of $82.50 per barrel). That’s an attractive price relative to Devon Energy’s valuation (it currently trades at a 12% free cash flow yield after including the expected accretion from Grayson Mills).
The company expects to capture about $50 million in annual cost savings. It also will enhance its margins in the region due to the midstream assets Grayson Mills owns. That associated business, which includes 950 miles of gathering systems, an extensive network of disposal wells, and crude storage terminals, will boost its earnings by about $125 million annually.
A solid deal for Devon
The Grayson Mills acquisition will certainly move the needle for Devon Energy. It’s paying an attractive price, making it immediately accretive to the company’s free cash flow. While it’s not quite as cheap as some of the company’s prior acquisitions (its $865 million purchase of RimRock’s Williston Basin assets in 2022 was at a 25% free cash flow yield), it’s a much larger deal. The transaction will solidify Devon’s position as a top-three pure-play U.S. onshore producer.
The accretive nature of the deal will significantly enhance Devon Energy’s free cash flow. That gave the company the confidence to boost its share repurchase authorization by a massive 67% to $5 billion through mid-2026. Given Devon Energy’s dirt cheap valuation (the S&P 500 trades at a 4% free cash flow yield, while the Nasdaq’s is around 3%), those repurchases should be highly accretive for investors.
The company has retired about 6% of its outstanding shares over the last three years. While Devon will issue some new shares to close this deal, it should quickly buy back a similar amount and offset that dilution.
Devon also plans to repay most of the debt it’s issuing to fund this deal. It’s targeting to allocate about 30% of its free cash flow toward debt reduction to pay off $2.5 billion over the next two years.
The company also expects the deal to be accretive to its dividend payment in 2025 and beyond. Devon has been growing its base dividend briskly. It has also been paying variable dividends (though it has been allocating more of its excess free cash flow toward share repurchases this year).
Devon is still a good oil stock to buy
After striking out several times, Devon Energy still found an attractive acquisition opportunity. While it’s not as big as some of the other deals it pursued, it should still move the needle for the oil company. Because of that, it enhances the buy thesis for Devon Energy.
It continues to trade at a cheap valuation, which it’s capitalizing on by repurchasing more shares. Add in its dividends and debt reduction, and Devon should have the fuel to produce compelling total returns in the coming years if crude oil prices cooperate.
Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.