Usually, when a stock offers an ultra-high dividend yield, it’s a red flag. It often signals distress, with the stock price (the denominator) having fallen so sharply that the dividend (the numerator) creates a misleadingly high yield. Relying on these can be risky – a dividend cut may be just around the corner.
Instead of focusing solely on payout ratios and dividend growth streaks, consider a little-known segment of the TSX: royalty income trusts. High yields are their specialty. Here’s what you need to know about these unique companies and three top picks to consider.
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What are royalty income trusts?
Imagine a popular burger franchise. The franchise owner grants the right to operate its brand to individual restaurants, collecting a percentage of their sales as royalties.
Now, take that royalty stream and turn it into a separate, publicly traded company. Investors in that company earn a share of the royalties as income.
The underlying asset doesn’t have to be a restaurant. It could just as easily be a gold mine, an oil reserve, or any other steady stream of something being sold. Regardless of the asset, royalty trusts focus on a predictable cash flow rather than directly operating the business.
These are “asset-lite” businesses because they don’t own the physical infrastructure or deal with the day-to-day operations of the underlying business. For example, a restaurant royalty trust doesn’t run kitchens or employ staff – it simply collects a slice of sales revenue.
Because they don’t carry operational responsibilities, royalty trusts tend to have little to no debt, making them less risky and more resilient during economic downturns.
Another hallmark of royalty trusts is their high profit margins, often exceeding 70%. This is because their operating expenses are minimal – they don’t have to cover costs like wages, inventory, or capital expenditures.
For investors, this combination of asset-lite operations, low debt, and high margins makes royalty trusts an attractive option for steady income.
3 TSX royalty income trusts I like
If you’re looking for high-yield royalty income trusts, these three stand out: Labrador Iron Ore Royalty Corporation (TSX:LIF), Freehold Royalties Ltd. (TSX:FRU), and Pizza Pizza Royalty Corp. (TSX:PZA).
Each focuses on a different sector – mining, oil and gas, and restaurants, respectively. Currently, their trailing 12-month annual yields are impressive: 9.9% for LIF, 8.3% for FRU, and 7.2% for PZA. FRU and PZA distribute income monthly, while LIF pays quarterly.
One important note: these dividends are “safe” in the sense that they’re covered by free cash flow right now. However, they are not guaranteed.
Each trust’s income depends heavily on the top-line revenue generated by the companies licensing their royalties. For example, a global commodities downturn could impact LIF and FRU, while an event like COVID could hit PZA’s restaurant revenues. This is why I would personally diversify and own all three.
