If you follow the news, you probably know that building a pipeline is a big hassle. But once you have one up and running, there’s no better business in the world…especially if you like collecting globs of dividend income.
Pipelines simply earn a fee on every barrel of oil that flows through them. As a result, their profits are not impacted by recessions or wars. Their cash flows are steady like bond coupons.
There’s little competition. Trucks and rail cars can’t compete once a pipeline is in place. Even if you wanted to build a competing line, chances are you couldn’t do it. The cost to acquire right-of-ways and to buy out landowners starts in the billions of dollars.
And while pipelines require a big upfront investment, they’re not that costly to maintain. Once laid, they just sit there. Maintenance costs are usually only a small percentage of revenues; the rest can be paid out to owners.
No wonder pipeline stocks like TransCanada Corporation (TSX:TRP)(NYSE:TRP) and Pembina Pipeline Corp. (TSX:PPL)(NYSE:PBA) are popular investments. However, for those of us with limited funds to invest it can be difficult to choose between the two.
So today, we’re tackling the question of which pipeline stock is a better bet for income investors. Let’s see how these two companies stack up on a range of measures.
1. Yield: This one was close. Today Pembina yields 4%, which is almost a half of percentage point over TransCanada’s payout. So, if you’re looking for current income, this stock is your first choice. Winner: Pembina
2. Dividend growth: For most income investors, this is about as deep as they research. If only picking out dividend stocks was as simple as selecting the companies with the highest yield. Unfortunately, we have to dig much deeper than that to determine the quality of an investment.
Dividend growth is also important because we want to ensure our income stream can keep up with inflation over time. That said, Pembina has only increased the size of its distribution by 1.5% annually in the past five years—not high enough to keep up with inflation. TransCanada, in contrast, has delivered a tidy 5.4% annual dividend growth over the same period. Winner: TransCanada
3. Earnings growth: Future dividend hikes will depend mostly on growing profits. Thankfully, pipeline companies are poised to deliver big growth for shareholders in coming years. Oil and gas production is surging across the continent. That means there’s an enormous demand for new energy infrastructure.
As a result, Pembina and TransCanada are projected to grow earnings per share by 5% and 10% annually over the next five years, respectively. That should translate into many more dividend hikes for shareholders. Winner: TransCanada
4. Dividend history: What is the worst case scenario for us income investors? Dividend cuts. That’s why reliability is so important. There’s nothing worse than watching our stream of income suddenly dry up.
That said, TransCanada is one of the most reliable dividend payers around. The pipeline giant has paid a distribution to shareholders every year since 1964. Pembina has a good track record of rewarding investors, too. However, the cross-town rival only started paying out dividends in 2010. Winner: TransCanada
5. Safety: Can we expect that tradition to continue? Probably. We can measure the safety of a stock’s dividend by looking at a company’s payout ratio. For pipeline companies, we take the total dollar value they pay out in dividends and divide this figure by total operating cash flow.
Thankfully, Pembina and TransCanada have conservative dividend policies. Both companies pay out only one-third of their operating cash flows, which gives them plenty of wiggle room if business sours. Winner: Draw
6. Valuation: The doldrums in the oil patch have hit energy equities hard and even the reliable pipeline names have not been spared. Today TransCanada and Pembina trade at 20 and 28 times forward earnings, respectively. That’s well below their historical averages, though in line with peers. Winner: TransCanada
And the results are in…
You really can’t go wrong adding either of these companies to your portfolio. That said, TransCanada is my favourite, given its faster growth, cheaper valuation, and longer track record. If you can only own one pipeline company, this is the stock to hold.
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Fool contributor Robert Baillieul has no position in any stocks mentioned.