Here’s the Energy Stock to Own in 2018

Freehold Royalties Ltd. (TSX:FRU) offers investors a 4.7% dividend yield and the real potential for additional dividend increases.

Karen Thomas, MSc, CFA

Author Bio

Karen Thomas began her investment career in 1998 and spent more than a decade working as an equity analyst and portfolio manager at investment management firms, including a major mutual fund company and a major pension plan. After gaining extensive experience in the investment industry, she decided that individual investors deserved access to the same knowledge and insights to help them take greater control of their financial futures. After the birth of her second daughter, Karen left her investment management career to write for The Motley Fool, where she has been helping investors make sense of stocks and the stock market for more than 10 years. Her work focuses on identifying undervalued opportunities and helping investors take a long-term approach to building wealth. Outside of investing, Karen enjoys spending time with her family and staying active outdoors.

Education

Master of Science (MSc) in Finance
Bachelor of Commerce, major in Finance and minor in International Business
Chartered Financial Analyst (CFA) designation, earned in 2000

Areas of Expertise

Energy stocks, long-term investing, value investing, and contrarian investing.

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Favorite Investment Quote

"Be fearful when others are greedy, and greedy when others are fearful." — Warren Buffett

Published February 22, 2018 7:27 am EST

While the price of oil has risen 15% since last year, Freehold Royalties Ltd. (TSX: FRU) has fallen 6.5%.

This is a company that I have been bullish on for a while now, as it is a great way to gain exposure to the Canadian energy sector. As a royalty company, with none of the operating costs associated with its production, it is a smart, defensive way to play the energy space.

And with strong results in the first nine months of last year, a dividend hike last year, potentially another dividend hike when the company reports full-year 2017 results in March, and a current dividend yield of 4.7%, Freehold is in good shape.

The company is engaged in the development and production of oil and gas, predominantly in western Canada. It focuses mainly on acquiring and managing oil and gas royalties, and royalty interests currently account for 90% of total production and contributes 97% of operating income.

In the first nine months of 2017, revenue increased 26%, cash flow increased 44%, and the company’s payout ratio was a very strong 55%.

The company’s debt has been reduced, as free cash flow of $94 million was put to use to pay off $36 million of debt and for $34 million in acquisitions, thus positioning the company for future growth through acquisitions of additional opportunities.

It’s safe and steady and has a low-risk business model for exposure to the energy space. Freehold is for those investors that would like exposure without as much risk as the average energy stock.

Another opportunity for investors looking for a higher-risk stock for a higher potential return is Baytex Energy Corp. (TSX: BTE)(NYSE: BTE).

The company is seeing internal rates of return in the 40-80% range on a per-well basis and is funding its capital-expenditure program with cash flow.

As a reminder, at $50 per barrel, Baytex is free cash flow neutral; at $55 per barrel, Baytex generates incremental free cash flow of $75 million; and oil at $65 per barrel means incremental free cash flow of $175 million.

And so with oil still above $60, operational momentum continuing, and a more than four times the interest coverage ratio on the company’s $1.5 billion in debt, things are looking good.

Baytex reports full-year 2017 results on March 8.

So, these are two energy names that I expect will make investors happy this year. Choose among them according to your risk tolerance and stay tuned for upcoming results when the stocks could potentially rally off strong fundamentals.