This year's oil price crash decimated the oil industry. With their cash flows plunging, oil companies cut everything they could to stay afloat, including dividends. The devastation flowed all the way to the top as oil giants BP and Royal Dutch Shell both slashed their once massive payouts to preserve cash.
However, not all oil-fueled dividends went down with prices this year, as several proved their durability. Two of those resilient payers are Devon Energy (DVN -0.49%) and Pioneer Natural Resources (PXD -2.98%). What's noteworthy about them is their future dividend plans, which makes them two of the safest income stocks in the sector.
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A special treat with more to come
Devon Energy currently pays a 4.6%-yielding dividend, which will certainly appeal to income-seeking investors. While higher-yielding dividends usually imply higher risk -- especially in the volatile oil sector -- that's not the case with Devon's payout. For starters, the company has an ultra-low oil price breakeven level to support its payout. Devon estimates that it only needs oil to average about $35 a barrel next year to support its operations, which is slightly below the current level of around $37 a barrel.
Meanwhile, the company has a strong cash-rich balance sheet. Devon ended the second quarter with $1.7 billion in cash, which will rise when it closes an asset sale next month. With the oil market stabilizing after taking a nasty tumble earlier this year, Devon plans to put some of that cash to work by retiring another $1.5 billion in debt, which will push its already low leverage ratio -- it's about half the peer group average -- even lower. That move will make its current high-yielding dividend even safer.
Then, as market conditions improve, Devon plans to increase its base payout. However, in addition to boosting the base level, the company also plans to pay special dividends when it has excess cash. It has already declared a $100 million special dividend, which it will fund with some of those asset sale proceeds. Future ones could come as oil prices improve, making it not only one of the safest dividend stocks in the oil patch but a potentially high upside one for income investors.
Adding some upside variability
Pioneer Natural Resources pays an above-average dividend that currently yields 2.3%, which is slightly above the S&P 500's 1.8% average. Like Devon's payout, Pioneer's is on rock-solid ground despite all the volatility in the oil patch because it also has an ultra-low breakeven level and fortress-like balance sheet.
Pioneer currently has the second-lowest leverage ratio in its peer group, which gives it nearly unparalleled flexibility to borrow money at low costs. For example, the company recently issued $1.1 billion of 10-year notes yielding 1.9%. That will enable it to refinance some existing higher-cost debt ($139 million of 3.45% 2021 notes and $244 million of 3.95% 2022 notes) and add some more cash to its balance sheet.
Meanwhile, the company's low-cost operations and strong oil hedging program have it on track to generate free cash flow after funding capital expenses and its dividend this year. Because it already has a top-tier balance sheet and produces free cash, Pioneer is considering ways to return excess money to investors in the future. It plans to do that by adopting a variable dividend framework for next year. That will enable the company to make additional dividend payments above the current base level if oil prices meet a certain threshold (likely above $45 a barrel for 2021). The company estimates that future variable dividends could significantly exceed its base dividend over time, suggesting big-time upside potential for income-seeking investors.
Ultra-safe base payouts with the opportunity for more income
With low operating costs and top-tier balance sheets, Pioneer Natural Resources and Devon Energy pay two of the safest dividends in the oil patch. However, what stands out the most about their payouts is the upside potential as both plan to layer in special and variable dividends in the future above their rock-solid base payouts. They could richly reward income investors in the coming years if oil prices cooperate while providing a nice income safety net even if they don't.
