Oil income can look wonderfully generous just before oil becomes less generous. That’s why I’d choose an energy holding by how it earns and spends money before admiring the yield. A royalty owner and an oil producer can both send monthly cash, but their bills are very different. For the income portion of my portfolio, I’d lean towards the business with fewer operating cheques to write.
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Collecting versus producing
Freehold Royalties (TSX: FRU) owns royalty interests in Canadian and U.S. energy properties. Other companies develop the land, and Freehold receives a share of production revenue under its agreements. It generally avoids funding the drilling and operating costs that fall on the producer.
That makes it attractive for income, although it doesn’t detach the dividend from energy prices. Lower prices reduce royalty revenue, while less drilling can weaken future production. Freehold depends on operators finding the land worth developing, so a royalty owner still has a business cycle to live through.
Its second-quarter dividend payout was 57% of funds from operations (FFO), management’s measure of operating cash earnings. That left cash for debt and acquisitions after the monthly payments. For Freehold, the breathing room is especially valuable because it can’t order higher oil prices when revenue disappoints.
Whitecap has more levers
Whitecap Resources (TSX: WCP) produces oil and gas. It can create growth by drilling productive wells and using infrastructure more efficiently. It also pays for the work, with capital spending needed to replace declining production as well as expand output.
Third-quarter funds flow reached $0.96 per share. Its new monthly dividend of $0.062 annualizes to $0.74, beginning with November’s dividend payable in December. Three payments at the new rate would use about 19% of that quarter’s funds flow, before allowing for capital investment.
That last spending claim is substantial for a producer. A low dividend share of funds flow doesn’t mean the rest is available for shareholders. I’d want production growth per share and debt discipline to survive a weaker price environment, rather than relying on a good commodity year to justify an ever-larger drilling programme.
Put equal dollars beside the payments
Here are alternative $10,000 purchases at the recent close, before fees. Freehold would produce about $54.63 monthly, versus $35.29 from Whitecap. That’s roughly $232 more annual income from the Freehold purchase. Its current yield is about 6.6%, compared with Whitecap’s approximately 4.2% using the new payment.
| COMPANY | RECENT PRICE | NUMBER OF SHARES | ANNUAL DIVIDEND | ANNUAL TOTAL PAYOUT | FREQUENCY | TOTAL INVESTMENT |
|---|---|---|---|---|---|---|
| FRU | $16.45 | 607 | $1.08 | $655.56 | Monthly | $9,985.15 |
| WCP | $17.48 | 572 | $0.7404 | $423.51 | Monthly | $9,998.56 |
I’d choose Freehold for current income because the royalty model and larger starting payment fit that job. Whitecap would be my alternative for an investor willing to accept more operating and capital-spending decisions in exchange for the producer’s growth opportunities.
Stress the cheque before spending it
If Freehold cut its dividend by 25%, the illustrated annual income would fall from $655.56 to $491.67. The monthly payment would drop to about $40.97.
I wouldn’t use that calculation to predict a cut. It shows the spending flexibility an energy-income investor needs. I’d keep either holding modest among other Canadian dividend stocks, with banks, utilities, and businesses outside resources supplying different earnings drivers.
A holding inside a Tax-Free Savings Account (TFSA) can generally shelter Canadian tax on receipts, provided contribution room is available. The shelter doesn’t cover an economic loss. Reinvesting before retirement can add shares, while spending the full payment means that part of the money isn’t compounding.
Bottom line
Freehold gets my next energy-income purchase, with Whitecap a credible choice for more production growth. I’d buy gradually and treat strong oil markets as a chance to strengthen the position rather than increase every household commitment. A payment that leaves room for an ordinary bad year is one I can hold more patiently.
