When searching for dividend stocks to buy for passive income, there are many variables to look for. Ideally, the stocks we choose check all the right boxes. But in reality, there’s usually something we have to give up.
Here’s a dividend stock to buy that has many strengths which make it an attractive option.
Peyto – one of Canada’s lowest cost natural gas producers
Peyto Exploration and Development Corp. (TSX:PEY) is a key player in the Canadian natural gas market, with production approaching 125,000 barrels of oil equivalent per day (boe/d). The company has a history of operational excellence that has helped it survive and thrive in the cyclical ups and downs of the natural gas industry.
This has been made possible by its 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.
A 10.95% dividend yield means significant passive income from this dividend stock
Yet, we cannot escape the fact that a 10.95% dividend yield often comes with big risks. Let’s explore this.
The first thing to look for is dividend coverage. How much of Peyto’s cash flow and earnings is being paid out in dividends? This exercise brings good news for Peyto. In fact, Peyto’s payout ratio is 62%. This means that the dividend is easily covered by Peyto earnings – a very good result.
Even better than this, Peyto’s dividend as a percent of cash flow is only 35%. In the first nine months of the year, cash flow from operations was $470 million. Total dividends paid were $163 million. Once again, a very strong number that can give us confidence in Peyto’s ability to cover its dividend.
So why the high dividend yield/low valuation?
Well, this comes down to the simple fact that Peyto’s business is cyclical. This means that earnings and cash flows are relatively unpredictable and open to volatility. Thus, investors are skeptical that the good fortunes will continue.
But, Peyto has a mitigating factor on its side. That is the fact that the natural gas market is experiencing a secular tailwind which can give us confidence in Peyto’s long-term future. Essentially, the North American natural gas industry is opening up to global demand. And the demand for it is strong. North America has the biggest natural gas reserves, and they are high quality, low cost, reliable, and easily accessible alongside the emerging liquified natural gas (LNG) industry.
For Peyto, this means additional sources of demand from different parts of the world. For example, LNG Canada is expected to begin shipments sometime in 2025. This Kitimat, British Columbia-based site offers many competitive advantages. For example, it boasts one of North America’s shortest shipping routes to Asia. Also, it’s a deep water, ice-free port. Finally, it has the necessary infrastructure, such as rail transportation and pipelines to transport natural gas to the facility.
Monthly passive income to count on
All of this means that we will likely continue to see Peyto thrive for a long time. The typical North American natural gas cycle that moves natural gas prices up and down is being interrupted. So, although natural gas prices have been hit recently due to high storage levels and mild weather, I remain bullish on the natural gas market and on Peyto.
As previously discussed, in the first nine months of the year, Peyto’s 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.
With LNG Canada expected to start-up in the foreseeable future, and Peyto’s steps to hedge a significant portion of its production volume at approximately $4 per mcf, I feel confident. The dividend will likely provide monthly passive income for years to come.
