After touching multi-year highs in 2022, several energy stocks are currently trading at lower valuations this year. Oil prices peaked in recent months due to the reopening of economies and Russia’s invasion of Ukraine. However, a macroeconomic slowdown globally has dragged crude oil prices lower.
Energy stocks are cyclical, which means they generate robust cash flows during periods of economic expansion. During bear markets, on the other hand, these companies struggle to maintain earnings.
In addition to traditional oil and gas stocks, you can also invest in royalty companies that have an asset-light business model. One such TSX stock is Freehold Royalties (TSX: FRU), which currently offers investors a dividend yield of close to 7%.
Is this TSX energy stock a buy or sell?
A Calgary-based dividend-paying oil and gas royalty company, Freehold has assets located in five Canadian provinces and eight states south of the border. It aims to acquire and actively manage royalties and provide a lower-risk income vehicle for investors.
Freehold claims it has one of the largest portfolios of royalty lands on the continent. Land holdings total 6.4 million gross acres in Canada and another 0.9 million gross drilling unit acres in the U.S.
Freehold has a royalty interest in over 15,000 producing wells and 350 units, allowing it to earn income from 250 industry operators. Its revenue includes lease rental streams, bonus considerations, and potash, which diversifies its cash-generating portfolio.
Basically, Freehold Royalties benefits from the drilling activity of its partners and does not deploy capital expenditures to expand production capabilities. It does not incur costs to operate oil wells or maintain production, which is paid for by industry operators. Freehold generates income from gross production revenue, which results in strong netbacks.
What next for this dividend stock?
In Q3 of 2022, royalty sales for the company totalled $98.4 million, an increase of 91% year over year. The increase in revenue was due to an improved pricing environment and higher production associated with third-party drilling on Freehold’s portfolio of properties.
Its funds from operations surged 50% year over year to $90.8 million, or $0.54 per share, in the September quarter. Freehold’s widening sales and profits enabled it to increase dividends by 102% to $0.26 per share in Q3. Despite an increase in dividends, its payout ratio stood at 47%, compared to 35% in the year-ago period.
Freehold Royalties currently pays investors annual dividends of $1.08 per share, translating to a forward yield of 6.9%. The royalty giant pays investors a monthly dividend of $0.09 per share, and these payouts have increased by 500% since April 2020.
While Freehold offers a tasty monthly yield to shareholders, you should understand dividends are not guaranteed. These payments can be suspended or revoked at any time. For example, during the financial crash, Freehold reduced dividends from $0.25 per share in November 2008 to $0.10 per share in January 2009. Similarly, monthly dividend payments were lowered from $0.14 per share in December 2014 to $0.09 per share in January 2015.
The Foolish takeaway
Due to the current pricing environment, analysts remain bullish on FRU stock and expect it to surge by 30% in the next 12 months. After accounting for dividends, total returns will be closer to 37%.
