The oil industry has an awful track record of creating shareholder value over the past decade. While oil-price volatility is one culprit, capital allocation has been another major factor contributing to the sector's poor performance. Oil companies have a history of chasing growth by investing in drilling as many wells as possible. On top of that, they typically repurchase shares during boom times (when stock prices are higher) and pull back during downturns (when prices are lower).
That's leading some oil companies to shift their capital allocation strategies. One of the producers at the forefront of this change is Pioneer Natural Resources (PXD 1.23%). That's one of the reasons that it tops my list of oil stocks worthy of an investor's consideration right now.
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A new framework
Pioneer Natural Resources initiated a new long-term variable dividend policy earlier this year to direct its capital allocation strategy. The framework would see the company distribute up to 75% of its free cash flow after paying its base dividend to shareholders each year. That would ensure investors receive the majority of any windfall from higher oil prices in the future.
The company's base plan is to invest enough capital to maintain its current production rate and pay its fixed quarterly dividend. It can currently fund both based on the cash flow produced at an average oil price of around $33 a barrel. It would then earmark up to 75% of any excess cash generated by higher oil prices toward the variable dividend. The other 25% would go toward debt reduction, share repurchases, and incremental production growth.
Pioneer Natural Resources would pay its base dividend in arrears. For 2021, the company intends to cap its variable payout at 50% of its free cash flow, with those payments coming on a quarterly basis in 2022. It will use the rest of the money to repay debt and fund incremental drilling activity.
The company is largely following the variable dividend blueprint laid out by Devon Energy (DVN 1.28%). The main difference is that Devon Energy pays its variable dividend based on its free cash flow in the prior quarter, rather than letting it build up over a year. Devon declared its first variable dividend earlier this year, which -- at $0.19 per share -- was almost double its base quarterly payout of $0.11 per share. That gives a glimpse of the upside potential of Pioneer's payout.
Adding fuel to the strategy
Pioneer has become an even more attractive oil stock following a recent deal that will enhance its ability to pay variable dividends. It's acquiring privately held DoublePoint Energy for $6.4 billion in cash, stock, and the assumption of debt and other liabilities.
The transaction does a few important things for Pioneer Natural Resources:
- It's an excellent strategic fit, as DoublePoint holds 97,000 high-quality net acres that directly offset or overlap Pioneer's existing position.
- The deal will immediately be accretive to all of Pioneer's key financial metrics, including earnings, cash flow, and free cash flow per share.
- Pioneer anticipates that it can achieve an additional $175 million in annual cost savings by joining forces with DoublePoint Energy.
Those last two features mean the deal will enhance Pioneer's variable dividend program. The deal's accretive nature implies that the company will produce more free cash flow this year than it would have without acquiring DoublePoint, suggesting a higher variable dividend. Meanwhile, the incremental cost savings will enhance Pioneer's ability to generate free cash flow in 2022 and beyond. Thus, it should increase Pioneer's future variable dividend payments.
A gusher of dividends even if oil prices fall
Oil companies tried to create value for their shareholders in the past by allocating their cash flow windfalls at higher prices into drilling more wells and buying back stock. Unfortunately, that strategy never paid off.
Now Pioneer is launching a new plan aimed at enabling investors to cash in on higher oil prices via its new variable-dividend program. That strategy, which it's enhancing with the DoublePoint Energy deal, should enable the company to generate attractive total returns -- and pushes Pioneer Natural Resources to the top of the list of oil stocks to buy these days.
