I don’t write a lot about Stephen Leeb, for whatever reason, so when an appealing story crossed my screen as a teaser pitch for his Leeb Income Millionaire newsletter I though we ought to take a look.
And when I read into it a bit and realized that the pitch was for one of my favorite kinds of investments, a royalty owner, I got doubly interested … so let’s look into it and see if we can identify this “secret” stock for you, shall we?
Here’s the gist of the pitch:
“By all accounts, King Charles II of England (1630-1685) was a charming guy.
“…Yet his reign was a near-total disaster for England.
“While exiled in the Netherlands, he launched a clumsy invasion of England, where he was defeated by Oliver Cromwell in 1651.
“Several years after reclaiming his throne in 1660, a huge fire burnt down nearly all of London.
“Then in 1667, he was defeated by the Netherlands in the Second Anglo-Dutch War.
“Yet, as humiliating as these disasters were, there’s another blunder Charles made that easily dwarfs them all.
“The history books mention it only in passing…only because they have no clue that it was a disaster.
“…A disaster so big, it has easily cost the Crown untold billions of dollars — a ‘lost fortune.'”
That “disaster” they refer to is the charter granted to the Hudson’s Bay company, and the ad says it was “phenomenally stupid” in part because it was granted in perpetuity — so it still stands.
Which is, of course, where Leeb’s stock comes in:
“The good news is, the Crown’s loss can be your profit.
“Because much of the land Hudson’s Bay used to own is now in the hands of a different company—one that’s sitting on an immense fortune it holds in perpetuity — and making investors insanely rich.
“Let’s put it this way: If you invested just $10,000 in it in 1996, you’d now be sitting on $179,000!
“That’s a 19% compounded annual return each year for 16 years!”
So which company specifically are we talking about here? Some of you who are well-versed in the world of Canadian energy companies might know the name off the top of your head, but I actually had to look it up … and for that some clues were helpful:
“… operating on its 3 million acres of land are over 30,000 working oil and gas wells producing 9,000 barrels every day….
“… unlike most companies involved in oil and gas production, this one…
- “Pays no cost for drilling and equipping the wells
- “Pays no cost to operate the wells
- “Pays no cost to maintain production, and
- “Pays no cost to restore the land
“Instead, all of these costs are picked up by industry heavy hitters desperate for the liquid gold underneath—companies like ConocoPhillips, PennWest, PetroBakken and nearly 200 more.
“In return for the privilege of drilling on the land, these producers pay royalties to the company from their oil and gas production….
“… this $1.6 billion company has become a MAJOR cash machine.
“In fact, over the last 17 years, it has handed investors $1.2 billion in dividends.
“For its size, this has to be one of the most generous companies I have ever seen.”
Enough? Yes, that’s plenty to feed into the gaping maw of the Mighty, Mighty Thinkolator and get you a nice, freshly-pressed answer … but just in case you’ve not yet been forced to salivate at Leeb’s hyperbole let’s add one little bit to make it clear how much he says he loves this:
“What’s more, it is perhaps the safest and surest thing I’ve ever come across in my career. To not take advantage of it would be liking whistling past a pot of gold.”
So … now do you want to know who it is? Thinkolator sez we’re being teased about: Freehold Royalties (FRU in Toronto, FRHLF on the pink sheets).
Freehold was launched as an income trust in 1996, then became a corporation in 2010 along with most of the other trusts (thanks to changes in Canadian tax law), and it is a decent-sized ($1.5 billion market cap) company that pays a pretty substantial dividend of about 7%. If you look at it on a PE basis it will look expensive, at about 30 times earnings, but because Freehold is externally managed and is almost entirely a collection of royalties they have very low expenses.
You can see the basics on Freehold in their latest Investor Fact Sheet here, and this is how they describe their land holdings that form the core of the value of the company:
“Our land holdings total just three million gross acres extending from northeastern British Columbia to southern Ontario, 94% of which are royalty lands. We have royalty interests in more than 30,000 wells (28,000 royalty wells) and receive income from over 200 industry operators. This diversity lowers our risk, while we benefit from industry drilling activity.
“As a royalty interest owner, we do not pay any of the capital costs to drill and equip the wells for production, nor do we incur costs to operate the wells, maintain production, and ultimately restore the land to its original state. The operators pay all of those costs and we simply receive a percentage of the production.”
The vast majority of their royalties come from Alberta, with substantial contributions also from southern Saskatchewan and northeastern British Columbia (no surprise, that’s where the big production areas are) and a few minor holdings in other provinces. Their production and reserves are both fairly well diversified across heavy oil, light oil, and natural gas and natural gas liquids — less than 40% comes from dry natural gas, though that number was probably substantially higher several years ago when gas prices were much higher. At this point a lot of the gas produced in Alberta is going straight into generating steam for in situ production of bitumen from the oil sands, I don’t know if they’re also getting royalties on that kind of production (essentially, “in situ” refers to melting the oil out of the sands underground and pumping it up — that’s where growth in oil sands production is coming from now, with most of the big oil sands reserves too deep to be surface mined like the long-producing Fort McMurray deposits).
Freehold has been around for decades now, and this is the first time I’ve ever looked at them. They are about 25% owned by the CN Pension trust funds (for railway employees), and those trust funds also own Freehold’s manager (Rife Resources) and Canpar holdings, another large royalty company that’s also managed by Rife.
The company believes that it is a Passive Foreign Investment Company (PFIC) under IRS rules, since the majority of their income comes from non-operated assets, so do be mindful of that if you’re a US taxpayer and you’re looking into possibly buying the stock yourself — PFIC is a much-feared and ridiculously complicated tax regime that was largely designed to make sure folks who buy offshore trusts and funds get taxed the same way as investors in mutual funds, but there are several options for how a US investor’s income and/or dividends or capital gains are treated under PFIC status so you should always know what your plan is before buying shares of such companies. I can’t explain it particularly well, and I obviously can’t give tax advice, but the Wikipedia page for PFIC is reasonably clear and the IRS form instructions are here. It’s not as bad as many folks will make it sound in chat boards, the actual tax due may not end up being overwhelmingly different, but you don’t necessarily benefit from any lower dividend tax rates like for qualified corporate dividends, or from deferral of taxes like you can with some trusts and MLPs, and it does add a little more recordkeeping and filing to your tax routine.
Unlike US oil trusts, Freehold has quite a bit of operating flexibility — they can drill their own lands if they want to, and indeed have invested some capital into working interests in wells to boost production (though they still get the lion’s share of their income from royalties and likely will do for the foreseeable future), and they can buy more royalties to build on their core land portfolio (US Trusts are more passive, they’re stuck with whatever they have at the moment they’re formed and are designed to deplete that specific asset over time). At this point revenue is roughly 1/3 from working interests, 2/3 royalties — but royalties have essentially no expense associated with them and their working interest has their share of the normal operating costs of drilling and production, so the royalties flow right down to operating income.
The company’s overhead and headquarters expenses (ie, everything but direct royalty and working interest costs) come in at around C$8 million a year and the management fee is another $4 million or so a year at the current pace (though the management fee is paid in shares). So that’s where their revenue goes — a bit to capital investment (though they’ve borrowed most of the capital for their larger commitments), some to paying down debt a bit recently and paying interest on the debt, and about 2/3 of their revenue gets pushed right through to shareholders as dividends.
They use the “funds from operations” term that’s familiar to owners of other companies that are focused on passing cash flow through to shareholders — that’s basically a “cash earnings” term, taking out “non cash” items like depreciation or depletion, and Freehold has been paying a consistent 14-cents-a-month dividend for about four years now that has them currently paying out more than 90% of their funds from operations. That’s a yield of just about 7.2% at the current price (about C$23 — all these numbers are in Canadian dollars). You can see the details of their most recent quarter here.
Seems like an interesting and pretty stable company — they focus on the stability of the dividend, not on dividend growth, so I wouldn’t expect to see a consistent hike in the income but it has been consistent enough for many years that, absent big drops in oil or gas prices, it can probably continue to compound pretty nicely if you reinvest dividends. And though it doesn’t have that “dividend growth” history that I generally like to see from income stocks, it should, thanks to their direct exposure to oil and gas prices, offer some inflation protection if we ever do get real inflation again. This is not a great match for my personal portfolio, since I own a similar (though recently less successful) MLP and am already overexposed to oil prices, but it’s the kind of flow-through, low-cost, royalty-based business model that generally appeals to me.
So there you have it — Stephen Leeb says it can make you 1,890% richer, which is what would have happened if you had put all your money into it in 1996 … that sounds a bit optimistic to me for future performance, but my bar is quite a bit lower than that for most investment ideas. It’s your money, though, so what do you think? Worth picking up Freehold for a 7% yield and some Canadian oil and gas exposure, with perhaps some growth potential from their working interests and their currently non-producing royalty lands, or do you need a higher yield or better dividend growth? Let us know with a comment below.
P.S. Yes, the company will “pass out” their next $9+ million in dividend checks on October 15, but don’t rush in just to get that 14 cents per share — they pay every month, and the ex-dividend date for next week’s payment was at the end of September so you wouldn’t get it if you bought the shares today.