Freehold Royalty Stock: 6.5% Yield, Even at $75 WTI (OTCMKTS: FRHLF)
When you want exposure to the price of oil with below average risk, royalty companies are generally a good idea. Two major oil royalty companies are listed in Canada. PrairieSky Royalty (OTCPK: PREKF) has already released its first quarter results (and those were good, as I explained in this article) while Freehold Royalties (OTCPK: FRHLF) publishes its financial results in a few weeks. We can, however, extrapolate Freehold’s performance to the fourth quarter of 2021 to try to determine how much cash flow the company will generate in the first quarter of the year, and I think the current weakness in its share price is a good opportunity to increase exposure.
Freehold Royalties has its primary listing in Toronto where it trades with FRU as its ticker symbol. As the company reports its financial results in Canadian dollars, I will be using CAD as my base currency throughout this article. The average daily volume in Canada is just under 900,000 shares, which represents over C$10 million in monetary value. Keep in mind that this company provides specific dividend tax information to US shareholders.
Fourth quarter results were excellent and give a good indication of what we can expect in the first quarter.
2021 was a big year for Freehold Royalties, which continued to expand its asset base, spending C$377 million on acquisitions. The majority of these acquisitions were made throughout the year when oil and gas prices were lower. While the P/CF multiples of the acquisitions were already good, the current high oil and gas prices make these acquisitions even better now.
The most recent purchase was completed in the first week of the last quarter, which also means that Q4 2021 was the first quarter where all assets contributed for an entire three-month period.
In the last quarter of the year, Freehold Royalties reported a total oil equivalent production rate of 14,005 barrels per day, of which 5,400 barrels were light and medium oil while an additional 1,250 barrels per day were classified as heavy oil. . The natural gas component represented approximately 6,000 of the 14,000 barrels of oil equivalent per day, meaning that Freehold’s product line was 59% petroleum and NGL.
The combination of oil and gas prices up 100% and a production rate up 45% from the last quarter of 2020 nearly tripled revenues from less than C$26 million over C$73 million.
Since Freehold has virtually no overhead, the FFO is just a little lower and the fourth quarter FFO was C$68.8 million. A good result considering the average oil price which was only $77.19 on a WTI basis. With the WCS oil price under C$79 and a natural gas price of C$4.93 in the quarter, it’s clear there’s a lot of added upside.
As PrairieSky reported an average WTI oil price of nearly $95 per barrel, Freehold’s first quarter results will obviously be positively impacted by the current price hike and it may even render the 2022 forecast obsolete.
2022 should be a good year even if the recent decline in the share price may lead you to think otherwise
Let’s first look at the official forecast for the current fiscal year. Freehold forecasts average production of 13,750 to 14,750 boe/day and using an oil price of $75 per barrel and a natural gas price of C$4 US$4, respectively, for gas sales in Canada and in the United States, funds from operations are estimated to be between 230 and 250 million Canadian dollars.
That’s less than the nearly C$275 million annualized profit generated by the company in the fourth quarter. The reason for this apparent drop can be found in the commodity prices used by Freehold. Oil prices of US$75 and used natural gas prices are lower than prices realized in the last quarter of last year.
So let’s assume that there will be no production growth and the production rate will remain relatively unchanged this year. At US$75 WTI, this would translate to an FFO of CA$235M. With less than 151 million shares outstanding, this would indicate an FFO/share above C$1.50. At $75 WTI.
The company’s December 2021 Investor Day provided sensitivity analysis on how the company expects its FFO to be impacted by higher or lower oil and gas prices.
So for every $1 change in the price of oil, the company will add $2.5 million per year to its FFO. A $0.25/mcf increase in the price of natural gas will increase the FFO by $1.6 million per year. Now let’s work with the oil price sensitivity and just accept the natural gas price average of C$4 and US$4 throughout the year (compared to the current spot price of C$6.2 and 6 US$.8).
The average WTI price in the first quartet was closer to $95/barrel and we are currently still trading at that level. If I used an average oil price of $85/barrel for the entire fiscal year, the FFO would increase by 10 * $2.5 = C$25M. And keep in mind that to generate an average of $85/barrel when the average price of oil was $95/barrel in the first four months of the year, the price of oil needs to average just $80/barrel for the rest of the year. Although I have a more cautious view of the price of oil over a longer term period, I think an average oil price of $80-85/bbl for this year is realistic.
But that means that at 14,000 boe/day, the FFO will drop from C$235m to C$260m or C$1.72/share. Applying a C$5/US$5 natural gas price would add an additional C$0.04 per share to the FFO calculation.
If we used the C$1.70 per share in the FFO as the base case and applied the minimum payout ratio of 60%, the dividend for the full year would be C$1.02/share. Freehold recently increased its dividend to C$0.08 per month, but paid only C$0.06 per share in the first two months of the year. If no further dividend increases occur, the dividend payment for the full year will be C$0.92 per share, approximately 10% below the company’s minimum payout ratio. So, unless the price of oil suddenly crashes, I think we could see an additional dividend or a special dividend being paid at the end of this year when the annual results are known.
At the current rate of C$0.08 per month, the dividend yield is approximately 6.5%.
At an average oil price of $80-85 a barrel, Freehold Royalties will likely be net debt free by the end of this year (YE net debt at the end of 2021 was around C$101 million) , which makes the current share price even more attractive. Even at $75 oil, Freehold Royalties is currently trading at a free cash flow yield of over 10%. And that free cash flow will grow as Freehold pays off all of its debt.
Full ownership remains one of the most attractive vehicles for exposure to the price of oil without having to face balance sheet risks or operational risks, as these are borne by the operators of the oil projects. Of course, it’s important that these operators stay in business, but at the current price of oil, or even $70 oil, that shouldn’t be a problem.
I have a substantial long position in Freehold Royalties and see no reason to change that. If anything, I’ll add more on the dips.