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Inter Pipeline Ltd: Is the 7% Yield Reliable?

Income investors have a wide assortment of high-yielding stocks to choose from right now, but many of the names come with big risks.

Let’s take a look at Inter Pipeline Ltd. (TSX:IPL) to see if its 7% yield is sustainable.

Record results

Inter Pipeline delivered strong Q3 2015 results. Net income came in at $128 million, up $33 million from Q3 2014.

That’s fine and dandy, but dividend investors are more concerned about free cash flow. Fortunately, that situation is also very strong.

Funds from operations hit $205 million in the third quarter, up 46% from the same period in 2014. The company spent close to $56 million on capital projects, so the business generated $149 million in free cash flow. That was more than adequate to cover the dividend payments of $123.5 million.

Strong oil sands numbers

The stock has come down on worries that oil sands companies will continue to delay or even cancel expansion plans. That’s certainly worth keeping in mind, but Inter Pipeline’s existing infrastructure is generating solid results.

Funds from operations in the oil sands segment rose 77% in Q3 2015 compared with the same period in the previous year. The increase is the result of two new pipelines that went into service in Q1 2015.

Oil sands companies have invested billions in their facilities with production outlooks that span decades. The current rout in oil prices is definitely painful, but Inter Pipeline’s customers are big companies with deep pockets that will continue to produce at low prices because the costs are simply too high to shut down the plants.

Storage results

Inter Pipeline operates a bulk liquids storage division in Europe. The group saw Q3 year-over-year utilization rates jump from 78% to 93%. This translated into record funds from operations of $29 million compared to $19.8 million in the third quarter of 2014.

NGL extraction

The NGL extraction business was the weak link in the third quarter with funds from operations dropping to $23.6 million from $34.4 million in the previous year. Difficult market conditions could continue to hinder this group in the near term.

Dividend safety

Inter Pipeline had a payout ratio of just 64% in Q3 2015. Management is obviously comfortable with the revenue and free cash flow outlook because the monthly distribution was increased by more than 6% in November to 13 cents per share.

At the time of writing, the dividend yields a juicy 7.1%.

Should you buy?

The revenue stream looks stable and two of the three business units are performing very well. A new storage facility is also scheduled for completion in 2016, and that should provide a boost to cash flow.

Investors should expect volatility to continue in the near term, but the energy market will eventually rebalance and Inter Pipeline’s shareholders could see a strong rally in the stock when oil recovers. In the meantime, you get paid very well to wait for better days.

If you have some room in your TFSA, this stock is should be a solid pick at the current price.

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Fool contributor Andrew Walker has no position in any stocks mentioned.

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