For passive income investors, finding the right TSX dividend stocks is a constant battle. I mean, we obviously want the highest dividend yields possible, but we have to be careful. Because high yields are high for a reason. Our job is to figure out whether the risks are greater than the potential rewards.
Here’s a TSX stock that has an 8.1% dividend yield that I think is not only sustainable but also has the potential to grow.
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A top natural gas TSX stock
Peyto Exploration and Development Corp. (TSX:PEY) is a key player in the Canadian natural gas market, with rising production and industry-low costs. The company’s operational excellence has driven it to survive and thrive in the cyclical ups and downs of the natural gas industry. This is a key point for those of us considering Peyto stock.
This resiliency has been made possible 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. This means relatively low capital intensity and high returns.
Is this TSX stock’s dividend safe?
This is a question that should be on our minds when considering a stock like Peyto. So, let’s look into it.
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 88%. This is an acceptable ratio, and it means that the dividend is covered by Peyto earnings – a good result.
Cash flow coverage is another key indicator of the sustainability of the dividend. In the first nine months of the year, cash flow from operations was $486 million. Total dividends paid were $193 million and capital expenditures totaled $338 million. This means that Peyto was $45 million shy of covering its capital expenditures and dividends. Not a great result, but read on, there’s more to the story.
Natural gas weakness
Canadian natural gas prices were exceptionally weak last year. This meant weaker-than-expected results from the likes of Peyto. But the company did manage well as hedging programs lessened the blow and allowed Peyto to achieve pricing that was almost four times higher than the market rate at the time. Furthermore, Peyto’s famously low-cost operations, which the company continues to drive lower, lessened the blow as well.
On the company’s latest earnings conference call, management expressed optimism regarding the future of the natural gas industry. Indeed, the natural gas market is experiencing a secular tailwind that can give us confidence in Peyto’s long-term future.
The future of natural gas
Essentially, the North American natural gas industry is opening up to global demand. And the demand for it is strong, as North America has the biggest natural gas reserves, which are high quality, low cost, reliable, and easily accessible. The liquified natural gas (LNG) industry has made this accessible to the world.
For certain, LNG Canada will help meet this demand. LNG Canada is located in Kitimat, British Columbia. This site offers many competitive advantages. For example, it boasts one of North America’s shortest shipping routes to Asia. With LNG Canada expected to start-up in the foreseeable future and Peyto’s use of hedging to reduce the risk of the business, I feel confident. Peyto’s dividend will likely provide monthly passive income for many years to come.
