Valued at $2.2 billion by market cap, Freehold Royalties (TSX: FRU) manages one of Canada’s largest non-government portfolios of oil and natural gas royalties with an expanding land base south of the border. Its total land holdings encompass 6.2 million gross acres in Canada and 1.1 million gross drilling acres in the U.S.
With interests in over 18,000 producing wells, the company receives royalty income from 380 industry operators. This diversity in cash-producing assets lowers overall risk, enabling Freehold to benefit from drilling activity on its royalty lands.
As a royalty-interest owner, Freehold does not pay any capital costs to drill and equip oil wells for production. Moreover, the operators pay the costs associated with operating the wells and maintaining production, while Freehold receives a percentage of the production.
An asset-light business model allows Freehold to distribute most of its cash flow to shareholders via dividends. Today, Freehold Royalties pays investors a monthly dividend of $0.09 per share, translating to a forward yield of 7.5%.
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The bull case for Freehold Royalties stock
In the first six months of 2024, Freehold Royalties reported an operating margin of 84% as it continues to add exposure to high netback and high return core areas in Canada and the U.S.
Its diversified land base provides free option value on continued tech advancements, new discoveries, and increasing development of emerging reservoir benches in the U.S. Freehold has invested close to $700 million since the start of 2023 to increase its U.S.-based revenues, which now account for 47% of the top line.
Freehold’s industry payors are located in eight states in the U.S. and five Canadian provinces. No single payor accounts for more than 15% of sales.
The bear case for investing in FRU stock
Freehold Royalties is part of the highly cyclical energy sector, meaning its revenue is tied to commodity prices. So, any significant fluctuation in commodity prices can impact its cash flows and dividend payouts.
For instance, in the 12 months before December 2008, Freehold paid investors an annual dividend of $3 per share. By August 2009, its annual payout fell to $1.20 per share as the mortgage crisis lowered oil prices.
The company also reduced its annual dividend from $1.68 per share in July 2015 to $0.48 per share in February 2017. Notably, the dividend payout fell to a record low of $0.18 per share in April 2020 as oil prices plummeted during the COVID-19 pandemic.
Alternatively, rising oil prices will mean Freehold competes with other players to acquire new royalty assets at elevated prices. This could lead to lower capital allocation efficiency and impact the profitability of new investments if cash flows are unable to consistently outpace acquisition costs.
Finally, several factors, including operational and regulatory challenges and output declines from existing wells, can impact Freehold’s production levels.
The Foolish takeaway
To date, Freehold Royalties has returned $2.2 billion to shareholders, indicating a cumulative payout of $35 per share.
Since its initial public offering in 1996, Freehold Royalties stock has returned roughly 12% annually. So, a $100 investment in FRU stock in 1996 would be worth $1,800 today if we account for dividend reinvestments.
