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Freehold Royalties Ltd. (TSX:FRU:CA) is a pure play oil and gas company that owns assets throughout North America. The company is a major player in the Permian and Eagle Ford basins as well as throughout the Canadian prairies. The important aspect to note is the company is completely royalty based, letting many of the industry’s big operators deal with the extraction and the associated costs. This means a lower reaction to changes in the oil price, and a consistent growing dividend yield due to the low price on oil assets. Freehold current yields a solid 7.1% as of today with room to grow based on US assets purchased in the last 3 years. Income oriented investors looking for something with more stability than some of the riskier exploration companies would do well to buy Freehold. The company has a stable base of over 380 partners, with no company working its lands at over 20% of revenue making it a diversified and interesting option for investors. However, do keep in mind that $2.2 Billion in market cap makes the company fairly small, and the oil sector is consistently volatile giving FRU some risk.
Freehold Royalty vs E&P (FRU ir)
Strong execution and cash flow
Q2 was a strong one for Freehold as production continues to be solid with 14667 barrels of production with a solid oil price underpinning it. Fund flows from operations were $53 million in Q2, which puts the dividend payout ratio at just 77%. The company continues to make good progress on leasing new locations with 67 agreements with 16 parties in the quarter. Freehold continues to see strong drilling activity with a record 528 gross wells drilled on their property in the first 6 months of 2023. The company is well diversified here, with both Canada and the United States seeing drilling strength. Net wells, which include the royalty rate FRU receives show the new revenues coming mostly from Canada. Year to date FRU has added 9.5 net wells in 2023, compared to 9.2 last year in the first half. This shows continued growth, as 2021 was just 5.61 net wells in the first half. Longer term this is an important metric as it shows potential for increase in production and cash flow – therefore dividend rate/capital appreciation.
Company debt owing is in a great spot with just $152 million of debt, and net debt of just $130.8 million. This is less than 0.5x the funds flow for 2023 which is expected to be at a minimum of $265 million with $80 WTI. Lately the oil price has been a tailwind as it has continued to move up with OPEC continuing to prove they will support the price at $80 per barrel. The company does have fair gas exposure with 62% of Q1 revenues from Oil will continue to be a modest headwind. Natural gas prices show no signs of increasing in North America for the next few years until better ways of selling overseas come online.
The company is planning on returning 60% of all cash flows to shareholders with the remaining 40% for acquisitions or debt repayment. While the yield is not the highest of all Canadian oil stocks or some globally, the yield is the most secure among them. As you can see above the company was still cash flow positive after the pandemic shook the industry and killed drilling during late 2020 into 2021. The royalty structure ensures more stable cash flow allowing the yield to increase over time and reducing the chance of dividend cuts. While the dividend was cut to 1.5 cents per month in 2020, it quickly rebounded after. The company has 12 years of US drilling inventory with a diversified revenue base between both the United States and Canada. This full diversification reduces any risk from one operator or region. While I would want to be at least oil neutral to own the stock, those who are quite bullish may want to look at the faster dividend growers in the oil sector which also trade at very low valuations relative to history.
Royalty History (FRU IR)
Conclusion – Buy for income investors
If you are looking for capital gains you want to pick another small or mid cap stock in the Canadian oil space. They can provide some dividend but more upside to the share price. However, those who are retired or looking for more stability and strong income should buy FRU. Considering that the company is not hurt as some other oil stocks may be by rising interest rates or lower oil prices, FRU has appeal to many. The stock has a better future of dividend increases compared to many other high dividend options in other industries, with more stability in its long-term outlook due to the energy space being so essential even over the next 20 years. OPEC will continue to support the oil price and keep a stable market with Freehold shareholders benefitting. I advise income-oriented investors to add to FRU on any pullbacks to build a solid position to supplement their income equities and bond portfolio.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
