It’s not often that we come across a quality stock with a dividend yield above 10%. Yet, this is what I’ve found in Peyto Exploration & Development (TSX:PEY). Peyto is one of Canada’s lowest-cost natural gas producers, and today, Peyto stock yields 10.7%.
Let’s explore whether now is a good time to buy Peyto stock (PEY) for exposure to this very generous dividend yield.
Peyto: A play on long-term natural gas prices
With a market capitalization of $2.4 billion and production approaching 125,000 barrels of oil equivalent per day (boe), Peyto is a key player in the Canadian natural gas market. Peyto’s stock price has been volatile over the years, as natural gas prices have fluctuated. However, financial results have been strong.
The company has a history of operational excellence that has given it resilience. This has been made possible in part by Peyto’s top-quality assets, which can be found in one of Canada’s most prolific basins, the Alberta Deep Basin. It’s a basin that’s characterized by a high return production profile, with high recoveries and predictability.
At this time, natural gas prices have settled much lower than last year’s levels. This is due to mild weather and record storage levels. On the bright side, liquified natural gas, or LNG, is a secular driver for natural gas prices.
The LNG market has been booming recently as many regions of the globe are looking for ways to meet their energy needs. This has given rise to a big natural gas LNG market in North America. Realized prices in the LNG market are higher than North American prices.
For Peyto, this is obviously a good thing. LNG Canada will likely be up and running in 2025, giving Peyto good access to the lucrative LNG market.
PEY stock’s dividend yield is well backed
Despite the long-term bullish trends, PEY has been weak as of late. In fact, it’s down 18% in the last month. Yet, the company continues to post strong results.
In the first nine months of the year, cash flow from operations was $470 million. Also, Peyto delivered an operating margin of 69%, a 25% profit margin, and a 12% return on capital employed. Lastly, dividends per share increased 122% versus last year. In fact, since 2019, Peyto’s dividend has increased 450%. This is a reflection of the company’s strong cash flows during this time period.
Looking ahead, Peyto has hedged a significant portion of its production volume for the next two years — 68% of its 2024 volume and 56% of its 2025 volume is hedged at a gas price of approximately $4 per one thousand cubic feet (mcf). Peyto’s cash costs are currently at $1.05 per mcf. This provides us with a little more certainty with regard to its cash flows and earnings.
Dividend coverage
Peyto’s dividend is currently higher than its net income, which means that its payout ratio is above 100%. More importantly, however, Peyto’s cash flows cover the dividend. In fact, its cash from operations of $470 million, easily covered its dividend payments of $175 million in the first nine months of the year.
This, along with Peyto’s growing production, strong hedging position, and the expected start of LNG Canada in 2025, gives me comfort that Peyto’s dividend is likely secure.
