The pullback in the market is serving up loads of juicy dividend yields right now, but investors are wondering which companies really have sustainable payouts when the return starts to drift above 6%.
It’s certainly important to sift through the carnage carefully, especially when the names are tied to the commodity space.
Let’s take a look at Inter Pipeline Ltd. (TSX:IPL) to see if it deserves to go into your dividend portfolio.
Canadian operations
The rout in oil prices has taken its toll on anything connected to the energy space. The sell-off in the producers and drillers is easy to understand, but the exodus out of the pipeline names looks a bit overdone.
Many investors haven’t even heard of Inter Pipeline, but the company plays a significant role in the transportation of oil in western Canada. In fact, Inter Pipeline operates more than 7,000 km of petroleum pipelines, owns 4.8 million barrels of storage, and moves about 35% of all oil sands production. It also carries 15% of western Canadian conventional oil.
You might be thinking it is best to stop reading right now, but there is more to this story.
Oil producer outlook
Oil sands producers are certainly under pressure. The price of crude remains stubbornly low and the Alberta government is raising taxes. That’s not an ideal situation, but these operations are built with a production horizon of decades, and the short-term discomfort, either in the commodity market or on the political front, should be put into perspective. Companies will adjust to higher taxes and royalty rates, and the result could be less expansion, but not a total shutdown of the industry.
When will prices recover?
Saudi Arabia is playing chicken with U.S. shale producers, but the Gulf country will eventually have to give in because they are burning through cash reserves at an alarming rate and can’t afford to cut their generous social handouts. I suspect the bottom of the oil rout is closer than many people think.
In the meantime, Canadian oil sands producers are going to keep mining the product because it costs too much to shut down the facilities. As long as they can generate enough revenue to pay the bills, they are going to stay the course.
Inter Pipeline has long-term agreements with its customers, who tend to be the big players, and that should ensure stable cash flow through the downturn.
While this is going on, the company is still investing in growth. For example, Inter Pipeline is building a $65 million storage facility that will add 400,000 barrels of capacity next year.
European assets
Inter Pipeline also has a growing storage business in Europe. The company is one of the region’s largest independent tank storage operators with assets located in the U.K., Ireland, Denmark, and Sweden.
The European business is doing well and provides a nice revenue balance when matched with the Canadian operations.
Cash flow
Dividend stability depends on cash flow. Inter Pipeline reported Q2 2015 funds from operations of $181 million, a 37.5% increase over Q2 2014. Net income rose by 12%.
The company pays a dividend of 12.25 cents per month that now yields about 6%. The payout ratio is 72%, so the distribution should be sustainable.
Should you buy Inter Pipeline?
Investors are unlikely to see the distribution increase next year, but the dividend should be safe. At this point, the stock looks attractive, and investors could see a big rally when oil starts to recover.
