Whenever I research a stock for income-oriented investors I am not very concerned about capital gains potential. Instead, I look for securities that will provide good cash flow with the likelihood of dividend increases going forward.
Also, I am very conscious of risk. No security is risk-free, of course, so I define the potential problems with every security I pick so that readers can make an informed judgment about whether the risk/return parameters are acceptable to them.
However, although capital gains are not the main goal, this does not mean we aren't looking for bargains. That's especially true in today's market, where income-generating stocks have been bid up to sometimes precariously high levels. Unless dividends have been increasing in lockstep, which rarely happens, the result is declining yields.
One of the few remaining sectors where there are good deals to be found is oil and gas. These stocks rallied following the announcement of production cuts by OPEC, but prices have retreated again recently and the S&P/TSX capped energy index is now in bear-market territory, off 20.6 per cent year-to-date. A pullback of that magnitude suggests there should be some decent opportunities available, so I did some investigating.
The stock I settled on is Calgary-based PrairieSky Royalty Ltd. Back in the summer of 2014, before the oil shock hit, you would have paid over $38 a share and received a monthly dividend of 10.58 cents ($1.27 a year). Then came the plunge in the oil price and the stock dropped all the way to $17.81 in January, 2016. The dividend was slashed by 43 per cent, to 6 cents a month (72 cents annually).
The stock rallied to the $34 range in December but then retreated again, closing on Monday at $29.23. At that level, I suggest the stock is worth a close look.
First-quarter results showed a significant improvement in PrairieSky's financial position. Revenue rose 64 per cent on a year-over-year basis to $80.3-million, from $48.9-million in the same period last year. Funds from operations were $67.3-million (28 cents a share), up from $41.4-million (18 cents) a year ago. Net earnings were $20.8-million (9 cents a share) compared with only $1.7-million (1 cent) in 2016.
Production increased to 26,812 barrels of oil equivalent per day (boe/d) at an average price of $30.45 boe. That compares with average daily production of 23,081 boe/d at a price of $20.58 last year.
The company's financial fortunes improved enough to allow for a small increase in the dividend in March, to 6.25 cents a month (75 cents a year), for a yield of 2.6 per cent.
PrairieSky is somewhat unusual in the energy business in that it is not actively involved in exploration and production. Rather, it leases land to E&P companies in exchange for a royalty stream on oil and natural gas production from the wells on its vast properties. This means the company does not incur the E&P costs of conventional energy producers although its profitability is still very much affected by movements in the prices of oil, natural gas, and natural gas liquids. The majority of its free cash flow is distributed to shareholders as dividends.
The company has one of the largest portfolios of "fee simple" lands in Western Canada (fee simple means it owns the sub-surface mineral rights). It has nine million acres across British Columbia, Alberta, Saskatchewan and Manitoba. Current activity is focused on the Viking light oil plays in Western Saskatchewan and Alberta, the multizone Deep Basin fairway of Alberta and B.C., and light oil deposits across central Alberta, including the Mannville area.
Management feels the shares are undervalued at the current price and is actively buying them back on the open market. During the first quarter, the company bought back 335,200 shares at a cost of $10.1-million.
Another big attraction is that, unlike most energy companies, PrairieSky has no debt and working capital of $97.6-million.
Although PrairieSky is not risky in the context of energy stocks in general, as mentioned, it is vulnerable to movements in the prices of oil and gas. So I rate this recommendation as higher risk. On the plus side, if oil moves to $60 (U.S.) a barrel in 2018, as some analysts are now predicting, we should see further dividend increases and an upward move in the share price. Ask your financial adviser if this stock is suitable for your portfolio.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.