How Safe Is Inter Pipeline Ltd.’s 6% Yield?

Inter Pipeline Ltd. (TSX:IPL) pays a monthly dividend. Shareholders receive $60 a year for a $1,000 investment. But how safe is its 6% yield?

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Inter Pipeline Ltd. (TSX:IPL) has gone down 32% to $24.5 from its 52-week high of $36. Due to the low oil-price environment, many energy-related stocks, including Inter Pipeline, have been sold off.

The business

Inter Pipeline is an energy infrastructure company that transports, processes, and handles 1.9 million barrels of energy products every day. For instance, it has a 3,800 km pipeline network located in western Canada that services more than 100 producers.

Its natural gas liquids extraction business processes about 40% of the natural gas that is exported from Alberta. Additionally, its bulk liquid storage assets handle over 100 different products and have a storage capacity of about 27 million barrels.

The business has a strong balance sheet with an S&P credit rating of BBB+. Its debt-to-cap ratio is 43%.

Dividend growth

Inter Pipeline has never cut its dividend since it began paying it in 2005. In fact, this is the seventh year the pipeline has paid a growing dividend. If Inter Pipeline maintains its monthly dividend of 12.25 cents, its dividend will have grown at a compound annual growth rate of 8.3% from 2008. That’s more than twice the rate of inflation.

Its more recent record is that its five-year dividend growth compounded at an annualized rate of about 10%, the highest among its peer group.

Since 2010, its payout ratio has remained below 80%, leaving some room for error. Healthy dividends are paid out from earnings. So it’s good to know that the business has been shifting to cost-of-service contracts that generate the safest source of earnings.

There’s no volume or commodity price exposure in EBITDA from cost-of-service contracts, and there’s also flow-through of operating costs.

Further, from 2009 to 2014, the business’s funds from operations have more than covered the dividend payout every year.

Stable earnings

Oil sands transportation is its biggest business segment that contributed to 60% of EBITDA year to date. The segment is built on long-term, stable cost-of-service contracts. More than 95% of that EBITDA is supported by investment-grade entities.

Since 2010, Inter Pipeline has been reducing the EBITDA coming from fee-based and commodity-based contracts, which are riskier than EBITDA cost-of-service contracts.

Fee-based contracts have no commodity price risk, but have volume and operating cost exposure. Commodity-based contracts have volume and commodity price risks.

About 30% of the pipeline’s EBITDA comes from fee-based contracts and about 8% comes from commodity-based contracts.

In conclusion

Inter Pipeline remains a stable business amid low oil prices. The business’s EBITDA is pretty stable with about 90% coming from cost-of-service and fee-based contracts.

The company believes these cash flows alone can support future dividends, so Inter Pipeline’s 6% dividend is safe and the business is well positioned to continue growing its dividend in the future.

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 Kay Ng owns shares of INTER PIPELINE LTD.

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