The energy industry is prone to dramatic highs and dizzying lows thanks to the commodity nature of oil and natural gas. Some companies, like ExxonMobil (XOM -2.78%), seek to soften the peaks and valleys, while others have chosen to embrace them. That's basically the case with Pioneer Natural Resources (PXD -2.28%) and Devon Energy (DVN 0.19%), which both have performance-linked dividends. But these two drillers aren't the same in all ways.
The landscape
The energy sector is broadly broken into three parts: the upstream, midstream, and downstream. They all face vastly different market dynamics, even though each is an integral part of the global energy system. Midstream companies like Enbridge own pipelines and other assets that help to move energy and largely charge fees for the use of their assets. Midstream companies tend to have consistent cash flows that support high dividend yields.
Downstream companies process energy into things like gasoline and chemicals. Not only does that expose these companies to volatile energy prices, which are an input cost, but their outputs (chemical and gasoline) are often commodities too. That said, low oil prices can be a net benefit for downstream companies, since it means lower costs. Energy majors like Exxon have material downstream operations to help offset the impact of weak energy markets.
The upstream segment is focused on drilling for oil. Financial performance in this business generally ebbs and flows along with oil and natural gas prices. It is often the most volatile part of the energy sector. This is where Pioneer and Devon Energy operate. As such, these two companies' top and bottom lines can vary greatly from year to year and even quarter to quarter, since energy prices are prone to swift and dramatic price changes. They have embraced that volatility by tying their dividends to performance.
DVN Dividend Per Share (Quarterly) data by YCharts
That's not a win for investors looking for consistent dividend income to live off of in retirement (a midstream stock would be a better choice). But shareholders will likely see huge dividend increases when oil prices are high. That could be used as a way to offset the real-world impact of higher energy prices on gasoline and heating costs. Simply put, when an investor is spending more to fill their gas tank and heat their house, they will be getting more generous dividends from Devon Energy and Pioneer to soften the blow.
Similar but different
Pioneer Natural Resources and Devon Energy have a lot of similarities. However, there is at least one notable difference that investors should be aware of when looking at each company's balance sheet. Indeed, a company's ability to pay dividends isn't solely a function of its earnings. It also needs to have a sound financial foundation, otherwise cash will have to be put toward debt reduction and interest costs instead of dividend payments. In a volatile industry like energy that's perhaps doubly important, since a downturn will eventually lead to hard times.
DVN Debt to Equity Ratio data by YCharts
Devon Energy's debt-to-equity ratio is currently at around 0.6. That's not unreasonable -- some of the largest energy companies in the world have similar ratios. That list, however, includes European energy companies BP, Shell, and TotalEnergies.
Those European energy companies carry higher levels of debt than U.S. counterparts Exxon and Chevron, offsetting the increased financial risk with higher levels of cash. Notably, BP and Shell cut their dividends when energy prices plunged early in the coronavirus pandemic as economies around the world effectively shut down to slow the spread of the illness. Exxon and Chevron, with lower leverage, took on debt to support their dividends, reducing leverage again when the energy market recovered. Pioneer's debt-to-equity ratio is currently around 0.3, which is closer to where Exxon and Chevron are.
XOM Debt to Equity Ratio data by YCharts
And Pioneer has recently announced plans to further reduce its debt levels, which should further improve its debt-to-equity ratio. It seems the goal is to be in an even stronger position to survive the energy industry's inevitable hard times so it can generously reward investors with huge dividends during the good times. Although that's not quite the same goal as Exxon and Chevron, which both have decades of annual dividend increases under their belts, it does suggest that Pioneer will have an easier time navigating energy downturns than Devon Energy.
The safer dividend option
Both Devon Energy and Pioneer have dividend policies that reward investors when energy prices are high, and ask them to share some pain via dividend reductions when energy prices are low. It's a model that won't be a great fit for all investors. But for those that do find the dividend models here appealing, Pioneer's lower leverage, and plans to reduce debt even further, provides an important backstop to its long-term dividend-paying ability that should probably put it ahead of Devon Energy.
