The price of oil has been extremely volatile recently.
And that is putting it mildly, because in fact, oil prices have been trading so seemingly erratically that energy companies are having a hard time making spending decisions.
I mean, it’s hard to make budget decisions when the most important variable that goes into your analysis is unbearably volatile and difficult to predict, in the short run as well as the long run.
But investors, don’t despair.
If you would like a piece of this volatile but very necessary industry that is trading at multi-year lows, but are too nervous to make the leap, I have the perfect stock for you.
With 99% of its operating income coming from royalties, Freehold Royalties Ltd (TSX:FRU) mitigates many of the risks that are inherent in this trade. And it’s a cheap stock.
With a highly diversified list of quality assets in a royalty model, it is a less-risky way to bet on the oil and gas market.
Trading at $8.82 at the time of writing, it has been hit hard in the last year, down almost 40%.
Here are the key reasons to own the stock:
First, Freehold stock currently has a dividend yield of 7.14%, and a dividend that is safe and well covered. You see, Freehold’s financials remain exceptionally strong, making this price action a great buying opportunity.
Second, Freehold is generating strong cash flows.
Operating cash flow increased 27% versus last year in the third quarter of 2018 and 9% versus last quarter.
Freehold Royalties generates free cash flow per share of approximately $0.70 at $50 oil and is well positioned to continue to create real value for shareholders.
To get a sense of the oil price leverage that Freehold has, a change in the oil price from $50 to $60 increases the company’s cash flow by more than 30%.
Third, Freehold’s payout ratio is enviable, coming in line with the company’s targeted 60% to 80% range.
Fourth, the company’s balance sheet is also enviable, with a net debt to cash flow ratio of 0.6 times.
Investors have enjoyed numerous dividend increases in recent times, as the company’s free cash flow generation has increased dramatically in accordance with the increase in oil prices.
And with oil trading just below $53 at the time of writing, Freehold looks set to continue along the path of strong free cash flow generation and dividend increases.
With limited exposure to capital costs, operating and other costs, Freehold’s royalty model is an attractive one for investors who would like exposure to the oil and gas industry without taking on as much risk.
Freehold can give you that.
Fool contributor Karen Thomas has no position in any of the stocks mentioned.
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