This Top Oil Stock Finally Rides the Sector Takeover Wave. Time to Buy?

The oil industry was inside a wave of mass consolidation triggered by Exxon‘S acquisition of Pioneer Natural Resources. Since then, most major oil companies have agreed to acquire a smaller rival to increase the scale of their operations and their ability to generate free cash flow.

Devon Energy (DVN -1.08%) is trying to participate in the merger wave. ​​Until recently, it had crossed out several times because his targets agreed to cooperate with another rival.

But Devon finally secured an acquisition that moved the needle. Here’s a look at that deal and whether it works crude oil stock purchase.

An in-depth look at Devon’s deal

Devon Energy has agreed to buy Grayson Mill Energy’s Williston Basin business for $5 billion. It is 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 the use of cash on hand and the issuance of additional debt.

This acquisition will transform Devon operations in Williston Basin, North Dakota. This will add 307,000 net acres to Devon, bringing the total area to 430,000 acres.

Meanwhile, Devon will triple its production in the regionadding 100,000 barrels of oil equivalent per day (BOE/d) to increase total production to 150,000 BOE/d. ​​This will make the Williston Basin the company’s second-largest operating area after the Delaware Basin (437,000 BOE/d) and more than double the production of the company’s second-largest region. The deal will also expand the company’s drilling resources in Williston, which are enough for about a decade.

Devon Energy expects the acquisition to be immediately accretive to key financial metrics per share, including earnings, cash flow, and free cash flow. It is paying approximately 15% free cash flow yield for Grayson Mill, assuming an average oil price of approximately $80/bbl (slightly below the recent price of $82.50/bbl). This is an attractive price relative to Devon Energy’s valuation (currently trading at 12% free cash flow yield after factoring in expected accretion from Grayson Mills).

The company expects to realize about $50 million in annual cost savings. It will also increase its margins in the region with midstream assets owned by Grayson Mills. This combined business, which includes 950 miles of gathering systems, an extensive network of disposal wells and crude oil storage terminals, will add about $125 million annually to its profits.

Reliable contract for Devon

The acquisition of Grayson Mills will certainly move the needle for Devon Energy. It is paying an attractive price, do it immediately increasing the company’s free cash flow. While it’s not as cheap as some of the company’s previous acquisitions (RimRock’s $865 million purchase of Williston Basin assets in 2022 yielded a 25% free cash flow yield), it’s a much bigger deal. The deal will solidify Devon’s position as one of the three largest onshore producers in the U.S.

The accretive nature of the transaction will significantly increase Devon Energy’s free cash flow. This has given the company the confidence to increase its share buyback authorization by a massive 67% to $5 billion by mid-2026. Given Devon Energy’s very low valuation (the S&P 500 index trades at a 4% free cash flow yield, while Nasdaq is around 3%), these buybacks should bring significant benefits to investors.

The company withdrew about 6% of its assets shares in circulation over the past three years. While Devon will issue new shares to close this transaction, it should quickly buy back a similar amount and offset this dilution.

Devon also plans to repay most of the debt it is issuing to fund the transaction. It intends to use about 30% of its free cash flow to reduce debt to repay $2.5 billion over the next two years.

The company also expects that the agreement be accretive to pay dividends in 2025 and beyond. Devon is rapidly increasing its base dividend. It also pays variable dividends (although it allocates more his excess free cash flow earmarked for share buybacks this year).

Devon is still a good oil stock to buy

After a few failed attempts, Devon Energy has still found an attractive acquisition opportunity. Although it is not as big as some With other deals it has pursued should continue to move the needle for the oil company. For that reason, it strengthens the buy thesis for Devon Energy.

It continues to trade at a low valuation, which it is taking advantage of by buying back more shares. Add to that dividends and debt reduction, and Devon should have the fuel to generate attractive total returns in the coming years if oil prices cooperate.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any stocks mentioned. The Motley Fool has a disclosure policy.