As the price of oil continued to melt down earlier this year, many investors switched from oil producers to companies further downstream. They continued to get exposure to the sector, while protecting themselves from the volatility of crude.
Because of this movement of capital, several of Canada’s largest pipeline stocks have actually gone up over the last 52 weeks, even though the price of crude has halved. Both Enbridge and TransCanada are up double digits over the last year (including dividends), with Enbridge pretty handily surpassing the return offered by its rival mostly because of plans announced to drastically up its dividend over the next few years.
But one pipeline has been left in the dust, actually declining a token amount over the last year, even though earnings increased from a number of new projects that were brought online, with more planned for the next few years. It has been brought down by a combination of weakness from the oil sands, a newly elected NDP government in Alberta, and continued weakness in natural gas.
Yes, I’m talking about Inter Pipeline Ltd. (TSX:IPL), one of Alberta’s largest transporters of crude. Let’s take a closer look at this company, with an emphasis on why I think the market has unfairly beaten it down.
The main issue with Inter Pipeline is the oil sands.
Essentially, the thesis goes like this: because many areas of the oil sands need crude to be at more than $60 per barrel to be profitable, investors are concerned that production will ultimately be cut in the region. Since 60% of Inter’s profits come from transporting bitumen from various projects in the oil sands, a slowdown in production from the region would likely affect profits.
But upon further thought, I’m not sure I buy the threat. Firstly, most oil sands projects are decades-long mega-projects, which have billions in upfront costs. They’re not about to be abandoned over a price blip. Plus, a full 92% of the company’s profits aren’t tied to commodity prices at all, meaning it gets paid the same amount whether crude trades at $50 or $100 per barrel.
Investors have to look at the long term with a company like this. Inter transports approximately 35% of all oil sands production, in pipelines that will become more and more important as time goes on. Remember, just a year ago, all the talk was about the shortage of pipelines in the area and the emergence of crude by rail.
Plus, Inter continues to expand. Two oil sands pipelines were brought online during the first quarter, and by the time the Cold Lake and Polaris pipelines are up to full capacity, they collectively will have the ability to transport more than one million barrels of crude per day.
Investors are getting a company that is rapidly expanding, and they’re getting it at a value price.
Based on the company’s first quarter funds from operations (FFO) annualized, shares trade at approximately 15 times projected 2015 earnings. That’s much cheaper than competitors, who tend to trade at about 20 times FFO.
Plus, Inter already has an attractive dividend. Shares currently yield 4.8%, as increased earnings fueled a dividend increase late last year. And with a payout ratio of just 73%, the company has plenty of excess cash available each quarter to put towards debt.
With a valuation more attractive than its peers, a dividend with room to grow, and a huge amount of potential capacity coming online over the next few years, I think now is a good time to buy Inter Pipeline. Investors are overreacting to crude’s decline, and chances of major production cuts from the oil sands are minimal. For those reasons, I think the stock deserves a spot in your portfolio.
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Fool contributor Nelson Smith has no position in any stocks mentioned.