Updated on March 29th, 2019 by Quinn Mohammed
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), and Royal Dutch Shell (RDS.B) – tend to come to mind.
Smaller energy companies can be a surprisingly good source of dividend income as well. 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 10 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 8.0%. And, Inter Pipeline pays its dividend monthly, making it ideal for retirees or other investors who need to budget their dividend payments.
Although monthly dividend payments are superior for many investors, they are quite rare. There are currently just 41 monthly dividend stocks, which you can access below (along with pertinent investment information):
Inter Pipeline’s strong dividend history, high dividend yield, and monthly dividend payments are three big reasons why the company appeals to dividend growth investors.
Business Overview
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 is headquartered in Calgary, Alberta, Canada and has a market capitalization of approximately $7 billion. The company is divided into four distinct segments for reporting purposes:
Oil Sands Transportation (48% of EBITDA) NGL Processing (34% of EBITDA) Conventional Oil Pipelines (13% of EBITDA) Bulk Liquid Storage (5% of EBITDA)More details about each of Inter Pipeline’s operating segments can be seen below.
Source: Inter Pipeline March 2019 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, Netherlands, Germany, Denmark, and Sweden.
A map showing the geographic distribution of Inter Pipeline’s operations can be seen below.
Source: Inter Pipeline March 2019 Investor Presentation, slide 4
The vast majority (95% of EBITDA) of Inter Pipeline’s business lies in its home country of Canada.
Growth Prospects
Inter Pipeline’s long-term strategy is to acquire and develop high-quality assets that generate stable and predictable cash flow, while delivering strong returns to shareholders.
IPL currently has ~$3.7 billion of announced and active capital projects, with another ~$4.4 billion identified potential projects.
Source: Inter Pipeline March 2019 Investor Presentation, slide 8
IPL has a proven track record of stable and impressive funds from operation (FFO) per share growth in periods of both the last ten and five years. Over the last ten years, FFO per share has grown by 8.3%, and 11.8% for the last five years.
FFO per share has been growing at a higher clip in recent years and we expect growth levels to remain the same or grow slightly due to large investments in their upcoming petrochemical complex.
Source: Inter Pipeline March 2019 Investor Presentation, slide 9
IPL is currently developing Canada’s first integrated propane dehydrogenation (PDH) and polypropylene (PP) complex, which will add a fifth segment to the business.
Polypropylene is a high-value and easy to transport plastic used in manufacturing a wide range of finished products, including consumer packaging, automobile parts, medical equipment, currency and textiles.
The project is scheduled to begin producing polypropylene in late 2021; from there Inter Pipeline expects to earn approximately $450 to $500 million per year in long-term average annual EBITDA. EBITDA of $450 to $500 million would represent approximately 40% of IPL’s 2018 total EBITDA.
The Heartland Petrochemical Complex will have the capacity to consume ~22,000 b/d of propane to produce ~525 kilotonnes per annum (KTA) of PP. The Alberta-produced PP is expected to have one of the lowest cash costs in North America due to the oversupplied propane market in Western Canada.
The majority of PP production is expected to be sold into the US market, where it is expected to have the highest price in the world. Demand for PP is expected to grow 22% over the next five years, from ~74,000 KTA to over 90,000 KTA in 2023.
IPL has invested ~$1.1 billion so far into the project, with another $1.1 billion expected in 2019. Financing for the project comes from a variety of sources, including an existing $1.5 billion committed credit facility, periodic issuance of new term debt, hybrid debt securities and undistributed cash flow from operations.
IPL has done a good job so far of de-risking the project by approximately 45% through lump-sum contracts, firm purchase orders and substantially completed time and materials works.
Competitive Advantages & 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 March 2019 Investor Presentation, slide 39
We would expect Inter Pipeline to perform relatively well during a recession because of its low-risk business model.
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. 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 $0.1425 in Canadian currency, which works out to approximately $0.11 per share in U.S. dollars. The annualized dividend payout of $1.32 yields 8.0% on the company’s March 28th closing stock price of $16.41.
The following diagram compares Inter Pipeline’s current dividend to its long-term historical average.
Inter Pipeline’s current dividend yield of 8% is meaningfully elevated above its 5-year average of 5.4%. The company is likely trading under its fair value (relative to historical norms).
As with any high yield dividend stock, investors should take a moment to assess the safety of Inter Pipeline’s dividend before purchasing this security.
The following diagram shows that Inter Pipeline’s dividend payments have been more than covered by its FFO since (at least) 2013.
Source: Inter Pipeline March 2019 Investor Presentation, slide 11
Looking at Inter Pipeline’s most recent quarter, the company reported per-share funds from operations of $0.51 and paid dividends of $0.32 per share (in U.S. dollars), giving it a payout ratio of ~63% 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 8.3% per year over the past decade.
We believe growth will be about the same or slightly higher going forward, and investors can expect FFO growth of 7%-10% over full economic cycles.
Thus, Inter Pipeline’s total returns will be composed of:
8.0% dividend yield 3%-5% FFO growthFor expected total returns of 11%-13% per year over full economic cycles.
Final Thoughts
Inter Pipeline has a number of characteristics that help it stand out to dividend investors, including 10 years of consecutive dividend increases, an 8% dividend yield, and monthly dividend payments.
Further due diligence reveals that this company appears to be a well-managed, profitable enterprise. While we cannot say we are particularly fond of its shareholder dilution, it is a growth strategy that has worked well (so far) for the company.
With the investments in the petrochemical complex, IPL’s fifth business segment should add significantly to EBITDA.
As a result, Inter Pipeline merits further research or potential investment for investors looking to accumulate additional energy exposure in their portfolios.