Topic: Value Stocks

Cash flow covers Inter Pipeline’s high yield

A Member of Pat McKeough’s Inner Circle recently asked for his advice on a company that transports, stores, markets and processes oil and natural gas in Canada and internationally.

Operations expansion has lifted quarterly revenue 25.1% and earnings, 18.9%. The stock currently trades at a modest 13.9 times the 2019 earnings forecast while yielding an impressive 8.3%. However, investors should be cautious, says Pat, given the company’s concentration on Alberta.

Q: Pat, can you give us your thoughts on holding Inter Pipeline and its high dividend yield? Thank you.

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Inter Pipeline Ltd. (Symbol IPL on Toronto; www.Inter, transports, stores, markets and processes oil and natural gas.

On September 1, 2013, Inter Pipeline changed from a limited partnership to a conventional corporation. The company is based in Calgary and has four business segments:

The oil sands operation (31% of its revenue) has three pipelines in Alberta that serve the Cold Lake and Athabasca oil sands projects. These operate on long-term cost-of-service contracts, which means that this revenue stream is well insulated from oil price fluctuations.

Conventional oil pipelines (29%) transport crude oil across Alberta and Saskatchewan. These pipelines operate on a mix of cost-of-service, fee-based, and commodity-based contracts. Its revenues are therefore less insulated from oil price fluctuations.

NGL Extraction (33%) converts Alberta natural gas to natural gas liquids (NGLs) such as ethane, propane and butane.

The bulk liquid storage business (7%) operates terminals in the U.K., Ireland, Germany, Denmark and Sweden.

Inter Pipeline’s revenue increased 64.3%, from $1.4 billion in 2013 to $2.3 billion in 2017. Over the same time, cash flow improved 109.6%, from $472.6 million to $990.6 million. Cash flow per share has increased 60.6%, from $1.65 per share in 2013 to $2.65 in 2017.

Value Stocks: Expanded operations leverage future oil and gas prices

The gains are mainly because the company has expanded its operations in the past few years.

Thanks to this ongoing growth, Inter Pipeline’s revenue in the three months ended September 30, 2018, rose 25.1%, to $685.0 million from $547.6 million a year earlier. Earnings in the quarter improved 18.9%, to $169.4 million, or $0.44 a share, from $142.5 million, or $0.38 a share. Cash flow increased 11.5%, to $299.7 million, or $0.77 a share, from $268.9 million, or $0.72.

In January 2018, Inter Pipeline began construction of the Heartland Petrochemical Complex, a major integrated plant that converts propane into high-profit-margin polypropylene plastic. The company will spend $3.5 billion on the project, which is located in Fort Saskatchewan, Alberta, and is scheduled for completion by the end of 2021. Inter Pipeline expects the complex to add $500 million to its cash flow each year.

In October 2018, the company acquired NuStar Europe for $270 million U.S. That firm owns seven coastal bulk liquid storage and blending terminals, totalling 9.1 million barrels of storage capacity. One of those facilities is in Amsterdam, and the others are in the U.K. NuStar will increase Inter Pipeline’s storage capacity by 33% to 37 million barrels and establish it as the largest independent storage operator in the U.K. The new operations are located in key industrial centres and have historically generated stable cash flow.

Inter Pipeline’s outlook generally rises and falls with oil and gas prices. Lower prices prompt producers to cut back on their output. That, in turn, lowers revenue for pipeline operators, because there is less oil and gas for them to handle. However, a lot of Inter Pipeline’s pipelines operate under long-term contracts with shippers—so that helps keep its revenue high.

The company’s concentration in Alberta also adds risk, as does its acquisitions. Still, its expansion in Europe and the U.K. offsets some of its geographic risk, and it aims to buy other profitable operations.

Inter Pipeline raised its monthly dividend by 3.6% with the December 2018 payment, to $0.145 from $0.14. The shares now yield a high 8.3%. However, that dividend is well covered by cash flow and appears safe. The stock currently trades at a modest 13.9 times the 2019 earnings forecast of $1.52 per share.

Inter Pipeline is okay to hold.


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