Freehold Royalties: Dependence on oil prices with a dividend yield of 8% (OTCMKTS:FRHLF)

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I like to invest in oil and gas royalties because it is one of the most convenient ways to participate in the prices of these commodities. Royalty companies pay an upfront fee to They receive a royalty fee but are not responsible for any investment commitments or investments made by the operator. Basically, the main risk for royalty companies is that the operator does a poor job.

: Freehold Royalties Ltd. (OTCPK:FRHLF, TSX:FRU:CA) is one of my favorite oil and gas royalty companies because the company combines attractive cash flows from its American and Canadian royalties with a generous dividend at an acceptable payout ratio. Since I haven't been on the pulse for the last two quarters, I think this is an opportune time to another look at Freehold.

The beauty of royalty companies: a very high conversion of revenue into free cash flow

In the second quarter of the year, Freehold's attributable production increased to 15,221 barrels of oil equivalent per day, with approximately 63% of attributable production coming from its Canadian assets.

About 40 percent of oil equivalent production comes from light and medium oil, while heavy oil (which trades at a discount to light oil) accounts for less than 10 percent of oil equivalent production. Natural gas accounts for about 36 percent of attributable production, and it goes without saying that the low price of natural gas is not working in Freehold's favor.

In fact, as you can see below, the average realized natural gas price was abysmal. The company only received $0.82 CAD per Mcf, mainly due to weak natural gas prices in the US, as the average realized price in Canada was slightly higher at $0.90 CAD.

Fortunately, strong oil and NGL prices mitigated the impact of the low natural gas price. In fact, although natural gas accounted for about 36% of the oil equivalent production rate, it contributed only 3% of total royalty revenue precisely because of the very low prices.

Total revenue was approximately C$84.5 million and as you can see below, operating costs are relatively low and consist primarily of depreciation and impairment charges related to the assets on which Freehold owns a royalty.

This resulted in pre-tax earnings of CAD 51.1 million (boosted by a foreign exchange gain of CAD 2.9 million compared to a foreign exchange loss of CAD 6.25 million in the second quarter of the previous year) and net income of CAD 39.3 million. With just under 151 million shares outstanding, earnings per share were CAD 0.26 per share, giving earnings per share for the first half of 2024 a value of CAD 0.49.

Remember that depreciation and impairment charges are not cash. Of course, the company will have to buy new assets to offset the impact of depreciation on existing assets. That is why it is important to generate strong operating cash flow, as this OpCF can be used to purchase new assets.

As shown in the statement of cash flows below, Freehold Royalties reported operating cash flow of $59.6 million before changes in working capital position. Other than one acquisition, there were no capital expenditures in the quarter (which of course makes sense considering Freehold is a royalty company and does not need to commit capital to operators' exploration and development plans).

Converted to the 150.7 million shares currently issued and outstanding, net FFO per share is C$0.395, or C$1.58 per share on an annualized basis.

Freehold Royalties currently pays a dividend of CAD $0.09 per share per month. Based on the second quarter FFO result, this means the payout ratio is around 68%. It also means the company retains around CAD $18 million in cash each quarter, which is currently being used to reduce net debt (and which could be used for further acquisitions).

Investment thesis

I own Freehold royalties to gain exposure to oil and gas prices, but of course I also like the monthly dividend payments. The C$0.09 per month is well covered, and Freehold has a good track record of acquiring new assets at acceptable prices to counteract the effects of depletion. I don't mind if the company uses the incoming cash flow to reduce its net debt, and hopefully it will be able to do new deals in the future.

I have a long position in Freehold Royalties.

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