A 6% dividend yield tends to trigger one of two reactions. Income investors either start calculating the monthly cash immediately, or they wonder what horrible surprise the market has hidden underneath it.
That second instinct is healthy. A big yield only creates useful passive income if the company can keep paying it. That means looking beyond the percentage beside the ticker and asking how much cash the business generates, how much goes toward the dividend, and what could cause that cash flow to disappear.
That’s why I’d rather own a 6% dividend covered comfortably by cash flow than chase a 10% yield hanging on by its fingernails. One less-talked-about TSX stock currently offers the former.
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FRU
Freehold Royalties (TSX: FRU) pays investors $0.09 per share every month, or $1.08 annually. With shares recently around $17.48, that’s a yield of approximately 6.2%. Rather than operating oil rigs itself, Freehold stock owns royalty interests across millions of acres in Canada and the United States. Energy producers develop those properties, and Freehold stock receives a portion of the resulting production revenue.
That means Freehold stock gets exposure to oil and natural-gas development without paying the enormous capital costs required to drill the wells. For investors exploring Canadian dividend stocks, that’s a pretty attractive arrangement. Operators spend the money, Freehold stock collects royalties. More importantly, recent results show that arrangement is throwing off enough cash to support the dividend.
Healthy income
Freehold stock generated $77.8 million in funds from operations during the second quarter, up 32% from the previous quarter. It returned $44.3 million to shareholders through dividends. That produced a 57% dividend payout ratio.
For income investors, that’s probably the most important number in this article. Freehold isn’t currently handing shareholders every dollar that walks through the front door. There’s room left for debt reduction, acquisitions, and the inevitable periods when commodity prices aren’t nearly as cooperative.
The balance sheet improved as well. Net debt declined by $24 million during the quarter to $251 million, bringing net debt to just 1 times trailing funds from operations. Meanwhile, operators drilled 300 gross wells across Freehold stock’s royalty lands during Q2, up 35% from the previous quarter. More drilling today can mean additional royalty-producing wells tomorrow, with Freehold stock largely leaving the construction bill to somebody else.
What would $10,000 produce?
At approximately $17.48 per share, a $10,000 investment would purchase 572 full shares for about $9,998.56. With each share currently paying $1.08 annually, those shares would generate roughly $617.76 per year, or an average of $51.48 per month.
| COMPANY | RECENT PRICE | NUMBER OF SHARES | ANNUAL DIVIDEND | ANNUAL TOTAL PAYOUT | FREQUENCY | TOTAL INVESTMENT |
|---|---|---|---|---|---|---|
| FRU | $17.48 | 572 | $1.08 | $617.76 | Monthly | $9,998.56 |
Investors who don’t need that money today could reinvest those dividends instead. Adding shares means the next dividend payment buys even more shares, gradually turning monthly dividend stocks into a compounding strategy rather than simply an income strategy.
Freehold isn’t particularly cheap compared with last year’s lows, however. The shares have risen more than 30% over the past year and sit fairly close to their 52-week high. I’m therefore buying this primarily for the income and business model, not because I expect another enormous rerating tomorrow.
Foolish takeaway
There are considerations. Freehold doesn’t pay to drill most of these wells, but its royalty revenue still depends heavily on the price received for the oil and gas produced. A severe oil downturn could squeeze funds from operations and eventually put pressure on the dividend. Freehold cut its payout during the 2020 oil crash, a useful reminder that no energy dividend deserves the word guaranteed.
Yet today’s numbers provide a decent cushion. Management says the current dividend remains supported around US$50 West Texas Intermediate (WTI), while the latest quarter’s 57% payout ratio leaves considerably more breathing room than the headline yield might suggest.
That’s why this 6.2% yield doesn’t scare me away. Freehold offers monthly income, reasonable payout coverage, falling debt, and exposure to future drilling without shouldering most of the drilling costs itself. Sometimes a high yield really does come with a catch. This one simply comes with oil.
