Published by Nick McCullum on July 4th, 2017
The energy industry is well-known for housing exceptional dividend stocks.
However, when we think of dividend energy stocks, the heavyweights – Exxon Mobil (XOM), Chevron (CVX), Royal Dutch Shell (RDS.B) – tend to come to mind. We generally do not immediately think of smaller, regional energy players.
Smaller energy companies can be a surprisingly good source of dividend income. Inter Pipeline (IPPLF) (IPL.TO) is one example of this.
On the surface, there’s a lot to like about Inter Pipeline. The company has increased its dividend for 14 consecutive years. This shows that Inter Pipeline is clearly committed to long-term dividend growth.
Along with its strong dividend history, the company has a high dividend yield of 6.4%. And, Inter Pipeline pays its dividend monthly, making it ideal for retirees or other investors who need to budget their dividend payments.
Inter Pipeline’s strong dividend history, very high dividend yield, and monthly dividend payments are three reasons why the company appeals to dividend growth investors.
This article will analyze the investment prospects of Inter Pipeline in detail.
Inter Pipeline is an energy infrastructure corporation that is engaged in the transportation, storage, and processing of energy products in Western Canada and Europe. Inter Pipeline trades on the Toronto Stock Exchange under the ticker IPL.
Inter Pipeline is headquartered in Calgary, Alberta, Canada and has a market capitalization of CAD$9.4 billion. The company is divided into four distinct segments for reporting purposes:
- Oil Sands Transportation (49% of EBITDA)
- NGL Processing (26% of EBITDA)
- Conventional Oil Pipelines (17% of EBITDA)
- Bulk Liquid Storage (8% of EBITDA)
More details about each of Inter Pipeline’s operating segments can be seen below.
Source: Inter Pipeline June 2017 Investor Presentation, slide 3
As mentioned, Inter Pipeline operates in two geographies: Western Canada and Europe.
In Canada, Inter Pipeline owns assets in two provinces: Alberta and western Saskatchewan.
In Europe, Inter Pipeline’s operations can be found in Ireland, England, Germany, Denmark, and Sweden.
A map showing the geographic distribution of Inter Pipeline’s operations can be seen below.
Source: Inter Pipeline June 2017 Investor Presentation, slide 4
The vast majority (92% of EBITDA) of Inter Pipeline’s business lies in its home country of Canada.
Inter Pipeline’s growth strategy is quite simple: issue new shares and use the proceeds to acquire high-quality energy infrastructure assets that generate revenue through long-term, risk-insulated contract agreements.
There are certainly benefits to this strategy.
By being a chronic issuer of shares, Inter Pipeline has a readily-accessible pool of capital that it can leverage to acquire additional assets.
However, Inter Pipeline’s growth strategy also has downsides.
Namely, the company’s share count has nearly doubled over the past decade.
Normally, this would be a very bad sign. Shareholder dilution can have a tangible negative effect on the intrinsic value of a business.
There are two situations where issuing shares to buy new assets can be beneficial for a business’ existing shareholders.
The first is when the company’s stock is overvalued. To put it simply, selling overvalued stock is a good idea whether you’re a investor or an employee in the treasury management department.
The second is when the assets being acquired are accretive to a company’s earnings-per-share.
For instance, if Inter Pipeline is trading at a price-to-earnings ratio of 25 and it is acquiring a company with a price-to-earnings ratio of 10, then every dollar of stock that Inter Pipeline issues to fund the transaction will result in an increase in pro-forma earnings-per-share once the transaction closes.
This is because the company being acquired is trading at a lower price-to-earnings ratio than the stock that is issued to fund the transaction. For Inter Pipeline, the relevant metric is likely funds from operations (not earnings-per-share), but the principles underlying the concept of EPS accretion remain the same.
So how do we measure the performance of Inter Pipeline’s potentially dilutive growth strategy?
We can look at the company’s per-share performance, shown below.
Aside form some lean times in 2013-2014, Inter Pipeline’s FFO per share has more than doubled over the past decade.
This shows that its company-wide funds from operations have grown at a much faster pace than its share count, indicating that its growth strategy is working. It is either 1. issuing overvalued stock, 2. engaging in accretive acquisition deals, or 3. some combination of the two (most likely).
Looking ahead, Inter Pipeline’s growth strategy will likely remain the same: issue company stock and use the proceeds to buy high-quality energy infrastructure assets.
Prospective investors should keep in mind that if Inter Pipeline purchases some less-than-stellar assets, they will be hit with the two-sided effect of 1. poor absolute financial performance and 2. dilution for existing shareholders.
Competitive Advantage & Recession Performance
Inter Pipeline’s main competitive advantage comes from its low-risk business model.
The company typically buys assets and sells their use to creditworthy counterparty under long-term, inflation-adjusted, commodity-insulated contracts.
Most of Inter Pipeline’s contracts are with highly creditworthy counterparties, with more than 80% of the company’s revenues being derived from investment-grade counterparties.
Source: Inter Pipeline June 2017 Investor Presentation, slide 33
The company also has a very attractive debt maturity profile.
Inter Pipeline only has one tranche of debt expiring in 2017-2019, and its debt thereafter is well-laddered, with a weighted average maturity of approximately 9 years.
The company also has an average cost of debt of ~3.6%, which shows that the financial markets view this company as a reasonably low-risk enterprise. Inter Pipeline has a BBB+ credit rating from S&P.
Source: Inter Pipeline June 2017 Investor Presentation, slide 34
I would expect Inter Pipeline to perform relatively well during a recession because of its low-risk business model. The company’s performance during the 2007-2009 financial crisis validates this claim:
Inter Pipeline’s FFO/share declined by about ~50% during the recession, although much of this was a retracement after a significant run-up starting in 2007. Further, the company recovered its previous level of profitability shortly thereafter.
Inter Pipeline’s low-risk business model and strong historical recession performance make it an attractive high yield dividend stock for investors building energy exposure in their portfolio.
Valuation & Expected Total Returns
Inter Pipeline’s future shareholder returns will be composed of valuation changes, dividend yield, and growth in FFO/share.
Inter Pipeline owns and operates long-lived energy assets like pipelines and storage tanks.
Accordingly, this company incurs significant non-cash depreciation and amortization charges which impair our ability to analyze its valuation using the traditional price-to-earnings ratio.
One straightforward alternative is to compare the company’s current dividend yield to its long-term historical average dividend yield.
Inter Pipeline currently pays a monthly dividend of $0.1350 which yields 6.4% on the company’s current stock price of $25.40.
The following diagram compares Inter Pipeline’s current dividend to its long-term historical average.
Inter Pipeline’s current dividend yield of 6.4% is meaningfully elevated above its 5-year average of 4.9% and slightly above its 10-year average of 6.3%. The company is likely trading slightly under its fair value (relative to historical norms).
As with any high yield dividend stock, we should take a moment to assess the safety of Inter Pipeline’s dividend before blindly purchasing this security. The following diagram shows that Inter Pipeline’s dividend payments have been more than covered by its FFO since (at least) 2011.
Source: Inter Pipeline June 2017 Investor Presentation, slide 7
Looking at Inter Pipeline’s most recent quarter, the company reported per-share funds from operations of $0.67 and paid dividends of $0.405, giving it a payout ratio of ~60% in the most recent quarter.
All said, Inter Pipeline’s dividend appears safe right now and for the foreseeable future.
The remainder of the company’s shareholder returns will be composed of FFO growth. Looking back historically, Inter Pipeline has grown its FFO at ~10% per year over the past decade.
I believe growth will be slower going forward, and investors can conservatively expect FFO growth of 4%-6% over full economic cycles.
Thus, Inter Pipeline’s total returns will be composed of:
- 6.4% dividend yield
- 4%-6% FFO growth
For expected total returns of 10.4%-12.4% over full economic cycles.
Inter Pipeline has a number of characteristics that help it stand out to dividend investors, including 14 years of consecutive dividend increases, a 6.4% dividend yield, and monthly dividend payments.
Further due diligence reveals that this company appears to be a well-managed, profitable enterprise. While I cannot say I am particularly fond of its shareholder dilution, it is a growth strategy that has worked well (so far) for the company.
All said, Inter Pipeline merits further research or potential investment for investors looking to accumulate additional energy exposure in their portfolios. This holds true especially for Canadian investors, as they will avoid any tax complications that occur from holding international securities in taxable accounts.