As the pandemic continues to wear on Canadian industries and businesses, the weight is being firmly placed on oil and gas companies.
Many oil and gas producers are still down over 50% on the year, and the outlook for the sector is undeniably bleak. What used to be a top sector when it comes to Canadian dividend stocks is now one Canadians are making sure to avoid.
However, there’s one portion of the oil and gas sector that may be a victim of negative investor sentiment when it really shouldn’t be. And that is pipelines.
After all, major Canadian pipeline company TC Energy said that not only was it’s business not effected at all by the pandemic, but it plans to move ahead with $37 billion in infrastructure projects.
But today, we’re not going to look at a major. We’re instead going to look at a smaller company, one that draws a lot of investors in by delivering high dividends, and that is Pembina Pipeline (TSE:PPL).
Lets analyze Pembina Pipeline (TSE:PPL) and its dividend
Pembina Pipeline is a midstream energy company that has operations primarily in western Canada and North Dakota. The company operates over 18,000 km of hydrocarbon pipelines and 1,650 km of heavy oil and oil sands pipelines.
Pembina is also an integrated company, as it has processing facilities, NGL infrastructure, and a marketing business. In fact, the company states that its integrated plants have the ability to heat over 12 million homes every year.
Overall, the company operates in three primary divisions: Pipelines, Facilities, and Marketing & New Ventures.
Much like other major pipelines here in Canada, the biggest draw for Canadian investors when they look at Pembina is its dividend. So, lets get right down to business.
Is Pembina Pipelines 8.96% yield safe?
The first thing that investors tend to do when searching for an income stock is look to the payout ratio. When they see a company like Pembina paying out 160% in terms of earnings, they simply move on the to the next stock due to fears of a dividend cut.
This isn’t inherently wrong. And Canadian investors may not even know any better, but some are being lazy. We need to look deeper when it comes to a pipeline company, and that includes free and operating cash flows.
Market Cap: $15.33 billion
Forward P/E: 13.78
Dividend Growth Streak: 8 years
Payout Ratio (Earnings): 143.18%
Payout Ratio (Free Cash Flows): Premium Members Only
Payout Ratio (Operating Cash Flows): Premium Members Only
1 Yr Div Growth Rate: 5.40%
5 Yr Div Growth Rate: Premium Members Only
Stocktrades Growth Score: Premium Members Only
Stocktrades Dividend Safety Score: Premium Members Only
At the time of writing, Pembina is paying out 161.54% in terms of earnings to pay its dividend. And if we look at the chart above, we can see that there is actually very few instances where Pembina, over the course of its 8 year dividend growth streak, doesn’t have a payout ratio that exceeds 100%. In fact, 2018 was the only year.
So, how did this company manage to become a Canadian Dividend Aristocrat with such high payout ratios? The thing is, they aren’t really as high as you think.
At the time of writing, Pembina Pipeline is paying out only 27% of its free cash flows towards its dividend. In fact, the company came out and stated in its most recent quarterly report that it has more than enough capital to fund both short and long term obligations.
“Pembina currently anticipates its cash flow from operating activities, the majority of which is derived from fee-based
contracts, will be more than sufficient to meet its short-term and long-term operating obligations, capital investment
requirements and to fund its dividends. ” – Page 19 of its 2nd quarter 2020 report.
In the quarter the company paid $347 million in dividends and posted adjusted cash flow from operating activities of just over $586 million. Keep in mind, adjusted cash flow from operating activities is declared after preferred share dividends are paid as well.
Overall, I don’t see a cut coming from Pembina, and Canadians grabbing this monthly dividend stock yielding near 9% are grabbing some hefty passive income. In terms of dividend growth however, I think we’ll see companies in the sector become extremely cautious. Over the last 5 years, Pembina Pipeline has grown its dividend at a rate of 6.50% annually.
Will it raise its dividend and continue its streak? Who knows. I think what investors are primarily looking for in the sector is for companies to keep their heads above water. So, I’d view a maintained dividend as good enough, even though they have ample room to raise.
But, the dividend isn’t all you should be looking for in an income stock. How is Pembina looking in terms of company growth, and stock appreciation?
Pembina Pipeline forward outlook and valuation
Forward outlook for Pembina has definitely taken a hit because of the pandemic. But, this isn’t because of cancelled projects, this is simply due to prudent management.
The company had a total of $5.635 billion in projects to get them to the end of 2021. Its capital restructuring plan has deferred over $4.5 billion of that in later years, and now projects that had direct in-service dates have been deemed “To Be Determined”.
And, the companies product makeup isn’t as solid as say a company like TC Energy, who has near 70% exposure to natural gas. Pembina in 2020 is expected to have 40% exposure to crude and condensate, and around 30% to NGLs and other gas.
Companies such as Tourmaline Oil (TSE:TOU) that have a larger helping of natural gas production and distribution have so far weathered this storm much better than plays that are more invested in oil production and distribution.
The company also has 80% exposure to the Canadian dollar and only 20% exposure to the dollar south of the border.
This is more than likely why Pembina is underperforming significantly when looking to its peers.
Charts provided by StockRover. Check out Stockrover Here!
Keep in mind, I did not include Inter Pipeline in the chart, primarily due to the fact that it cut its dividend.
In terms of valuation, Pembina is trading at a significant discount to historical numbers. With a price to sales of 2.4 and forward price to earnings of only 13, this represents 28% and 38% discounts in terms of 5 year historical averages, respectively.
There is no question Pembina is cheap right now, but it is likely cheap due to the fact its growth is expected to stall. In fact, analysts estimate that after losing 14% of revenue in 2020, the company will continue to post revenue losses in the 3% range next year.
Compare this to a company like TC Energy, who is expected to have flat revenue this year before having high single digit revenue growth in 2021, and we can see why Pembina is trailing them in terms of year to date returns by nearly 20%.
Overall, Pembina is a solid option for income investors, but is it the best option in the pipeline sector? I’d say no. I’d much rather invest in a company like TC Energy, which has more exposure to natural gas, and significantly more projects to fuel growth coming down the pipeline, no pun intended.