Pat McKeough responds to many requests from members of his Inner Circle. Every week, his comments on the most intriguing questions of the past week go out to all Inner Circle members. Each week, we offer you a highlight from these Q&A sessions. Today he looks at a Canadian dividend stock that’s a holdover from the income trust boom, as it collects royalties from oil and gas producers.
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Q: Pat: Can I have your advice on Freehold Royalties Ltd.? Thanks in advance.
A: Freehold Royalties Ltd. (symbol FRU on Toronto; www.freeholdroyalties.com) holds oil and natural gas rights on 3.5 million acres of land in Alberta, Saskatchewan, B.C., Manitoba and Ontario.
These reserves are 47% natural gas, 24% light crude oil, 22% heavy crude oil and 7% natural gas liquids.
Freehold collects royalties from oil and gas producers that operate over 38,000 wells on its land, in addition to holding royalty interests in seven potash mines in Saskatchewan. Long-life royalty properties account for about 75% of Freehold’s cash flow, and wells it has a working interest in, and shares the cost of operating, supply the remaining 25%.
The company converted from an income trust on January 1, 2011.
In the three months ended March 31, 2015, Freehold’s revenue fell 43.6%, to $27.8 million from $49.2 million a year earlier. That’s because lower oil and gas prices offset contributions from recent acquisitions. Overall cash flow dropped 28.2%, to $21.9 million from $30.8 million, while cash flow per share declined 35.6%, to $0.29 from $0.45, on more shares outstanding.
Penn West Petroleum latest of the Canadian oil companies to make major sale to Freehold
Freehold continues to add to its landholdings. In May 2015, it bought 325,000 acres in Alberta and Saskatchewan from Penn West Petroleum (symbol PWT on Toronto) for $318 million.
To help pay for this purchase, the company raised $405 million by selling 22.5 million shares at $18.00 each. It will put the remaining funds toward its $140.0 million of long-term debt (as of March 31, 2015), which is already low at just 8% of its market cap.
The company currently pays monthly dividends of $0.09 a share, for a 6.2% annualized yield. In the latest quarter, dividends accounted for 92.7% of its cash flow, but 35% of its investors reinvest their dividends in new shares. If you adjust for this, the payout ratio is a more reasonable 54.6%.
Freehold’s stock is down 35% in the past year, as depressed oil and gas prices have forced many producers to put off their expansion plans. As well, 69% of the company’s landholdings are in Alberta, and the province’s new NDP government could impose higher royalties or bring in tougher environmental regulations, either of which would likely slow drilling.
Still, the company’s strong balance sheet and steady cash flow should let it keep buying up properties at low prices from distressed sellers. Like most oil and gas-related stocks, Freehold needs higher prices to show significant cash flow growth, but it’s well positioned for when oil and gas prices recover.
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