The versatility of the Tax-Free Savings Account (TFSA) in Canada is unparalleled, given how it can serve many purposes. Accountholders can use the tax-advantaged investment account to save for short-term financial goals, set up an emergency fund, finance retirement, and achieve other plans in between.
But if the objective is to produce unobstructed cash flows, one dividend stock can turn your TFSA into a passive income machine. Freehold Royalties Ltd. (TSX:FRU) isn’t an oil and gas producer but an owner of mineral titles and royalties in oil and gas properties.
Furthermore, the dividend yield is high (7.58%), and the payout frequency is monthly. The share price is less than $15 ($14.70 per share), and your holdings will dictate the potential income streams. If the dividend per share (stock price times yield) is $1.11, 2,000 or 4,000 shares will generate $185.71 or $371.42 tax-free income monthly, respectively.
However, the TFSA has annual and lifetime contribution limits. You can only make a large upfront investment if the available contribution room is equally significant. For 2023, the cumulative lifetime contribution room is $88,000.
Otherwise, you could contribute the annual maximum of $6,500 and keep maxing out the limits in succeeding years. Assuming you start with $6,500, you’d initially generate $40.90 per month until you can accumulate more shares yearly.
Superior asset classes
Freehold Royalties manages a sizeable land base in North America. The land holdings in Canada are approximately 6.4 million gross acres, and the exposure in the U.S. is around 0.9 million in gross drilling acres. The $2.2 billion energy royalty corporation believes its minerals and royalties are superior asset classes.
The overall royalty interests are more than 18,000 producing wells and 350 units in five Canadian provinces and eight states across the border. Around 380 industry operators or drillers pay royalty income. Freehold’s top payors include ExxonMobil, Canadian Natural Resources, Crescent Point Energy, and Tourmaline Oil.
Being the royalty interest owner, Freehold spends $0 on capital costs like drilling and equipping the wells for production. It incurs zero costs to operate the wells and maintain production. The well-capitalized royalty payor shoulders all costs and related expenses.
Royalty advantage
Freehold’s dividend history is long, extending back to 1996 without a missed payment. Upon the approval of the Board of Directors, management raised its dividend six times in the last 11 quarters. Because of lower costs from royalties, the energy stock can sustain higher returns to shareholders.
Moreover, the royalty model maintains a material netback advantage over traditional exploration and development companies. It also generates free funds flow through all commodity cycles, regardless of the underlying commodity environment.
Freehold has a strong netback because the royalty income is based on gross production revenue (before the deduction of royalty expenses and operating costs). In 2022, revenue reached a record $393 million, representing 170% more than its five-year average.
Lower-risk, attractive returns
Besides the non-exposure to capital and operating costs, an inflationary environment will not impact Freehold’s profit margins. The passive income machine can live up to its promise of delivering lower-risk, attractive returns over the long term.
