2 Big Reasons Dividend Investors Should Avoid Pembina Pipeline Corp., and 1 Stock They Should Buy Instead

Pembina Pipeline Corp. (TSX:PPL)(NYSE:PBA) has performed very well recently. But there’s a better option in the industry.

| More on:
The Motley Fool

If you’re looking for reliable dividends, the pipeline companies are a great place to look. After all, they operate critical infrastructure, make recurring revenue from long-term contracts, and also benefit from increased energy production in western Canada.

And among the pipeline companies, none has been a hotter performer than Pembina Pipeline Corp. (TSX: PPL)(NYSE: PBA). Over the past five years, Pembina’s stock has skyrocketed by over 220%, and shareholders have collected a nice dividend along the way.

But there are reasons to avoid the stock, and two are listed below. Then we highlight a pipeline company you should buy instead.

1. A high price to pay

It’s no secret that Pembina shares have performed very well. In fact, last year the company had the top-performing shares of any Canadian company in the energy infrastructure industry. But that’s left one big problem: an expensive stock price.

To illustrate, let’s look at 2013. The company had cash flow from operations of just over $2 per share. This does not mean the company earned that kind of money. Remember, maintaining pipelines requires lots of capital expenditures, which is not included in the number above. So the real earnings power of the company was likely well below $2 per share.

Yet Pembina still trades at nearly $50 per share. So that means one of two things: Either the company has to devote all its cash flow to dividends, leaving little room for growth, or you’ll have to accept a tiny dividend yield. Neither is appealing.

2. Dilution

As it turns out, Pembina has chosen option A with regards to its dividend, with an annualized payout of $1.74 per share (paid monthly).

This is more than the company can pay just from cash flow. So what does it choose to do? Well, if you own Pembina shares, you can opt in to the dividend reinvestment plan (Drip), which offers you the chance to receive your dividend in shares rather than cash. As a bonus, you get a 5% discount for doing so. Last year, Pembina paid only $220 million in cash dividends; without the Drip, it would have had to pay roughly $500 million.

This creates a problem: Pembina’s share count keeps growing. The weighted share count increased by nearly 20% in 2013 alone. This makes dividend raises very difficult — from 2004 to 2013, the dividend grew by only 4.6% per year. If you’re looking for some growing cash income, you should look elsewhere.

1 stock to buy instead: TransCanada

TransCanada Corp. (TSX: TRP)(NYSE: TRP) is Canada’s second-largest pipeline company. And it seems to be a better option than Pembina.

For one, its shares are not as expensive, trading at only about 12 times last year’s cash flow from operations. Secondly, the company pays a very affordable dividend. So there’s no need to issue discounted shares — last year, TransCanada’s share count increased by less than 1%. As a result, there’s no disincentive to receiving cash income, and the company’s dividend can grow a lot faster.

Absent from this conversation is Enbridge Inc., Canada’s largest pipeline operator. But the free report below is about Enbridge. So with that report, you should have all the information you need on this industry.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Benjamin Sinclair has no position in any stocks mentioned.

More on Dividend Stocks

Female hand holding piggy bank. Save money and financial investment
Dividend Stocks

RRSP Savings: 2 Top TSX Dividend Stocks to Build Retirement Wealth

Here's how investors can turn small initial RRSP contributions into substantial savings for retirement.

Read more »

Man holding magnifying glass over a document
Dividend Stocks

2 BMO ETFs Are Less Volatile Than BMO Stock

Two ETFs of a big bank are more suitable for risk-averse or ultra-conservative investors than its stock.

Read more »

Target. Stand out from the crowd
Dividend Stocks

1 Cheap Dividend Stock to Buy as Recession Fears Rise

Great-West Lifeco (TSX:GWO) is an undervalued financial stock that looks like a great buy, even as the world economy tumbles…

Read more »

Profit dial turned up to maximum
Dividend Stocks

2 TSX Stocks Paying Over 5% in Dividends

Add these two blue-chip dividend stocks to your portfolio for wealth growth through shareholder dividends and capital gains.

Read more »

Business people standing near houses models
Dividend Stocks

2 REITs to Own as Rental Housing Demand Rise

Two prominent residential REITs should be on your buy list, as the rental housing market picks up due to rising…

Read more »

Retirement plan
Dividend Stocks

FIRE Movement: How to Retire Early Using Your TFSA

You can increase your financial independence and even retire early by investing in solid dividend stocks in your TFSA over…

Read more »

Senior Man Sitting On Sofa At Home With Pet Labrador Dog
Dividend Stocks

RRSP Investors: 2 Stocks to Buy Now for a Personal Pension Fund

RRSP investors can find top TSX dividend stocks at cheap prices today.

Read more »

Cogs turning against each other
Dividend Stocks

1 Passive-Income Stock to Counter Volatility

Looking for a stock that can counter volatility now and tomorrow? This stock is a reliable option for growth and…

Read more »