Devon Energy's Dividend X-ray
Not all dividends are created equal. Here, we'll do a top-to-bottom analysis of a given company to understand the quality of its dividend and how that's changed over the past five years.
The company we're looking at today is Devon Energy (NYS: DVN) , which yields 1.1%.
Devon Energy is an exploration and production company. Although other companies such as ATP Oil & Gas (NAS: ATPG) and ExxonMobil (NYS: XOM) have been searching all over the world for oil and have global offshore assets, Devon recently sold off its offshore assets to focus solely on onshore North America. Devon Energy has one large advantage over other players in that it has its own drilling fleet. It was a pioneer of horizontal drilling and doesn't have to contract out to drilling companies, as competitor Kodiak Oil & Gas (NYS: KOG) recently did with Halliburton (NYS: HAL)
To evaluate the quality of a dividend, the first thing to consider is whether the company has paid a dividend consistently over the past five years, and, if so, how much has it grown.
Although its share's really haven't gone anywhere, Devon's dividend has steadily grown over the past five years.
To understand how safe a dividend is, we use three crucial tools, the first of which is:
- The interest coverage ratio, or the number of times interest is earned, which is calculated by earnings before interest and taxes, divided by interest expense. The interest coverage ratio measures a company's ability to pay the interest on its debt. A ratio less than 1.5 is questionable; a number less than 1 means the company is not bringing in enough money to cover its interest expenses.
Devon covers every dollar of interest expense with $12 of operating earnings.
The other tools we use to evaluate the safety of a dividend are:
- The EPS payout ratio, or dividends per share divided by earnings per share. The EPS payout ratio measures the percentage of earnings that go toward paying the dividend. A ratio greater than 80% is worrisome.
- The FCF payout ratio, or dividends per share divided by free cash flow per share. Earnings alone don't always paint a complete picture of a business' health. The FCF payout ratio measures the percentage of free cash flow devoted toward paying the dividend. Again, a ratio greater than 80% could be a red flag.
Source: S&P Capital IQ.
As you would expect from a company investing a great deal in new exploration, Devon's payout ratios have been volatile.
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