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Looking for an 8% Dividend Yield With Massive Upside? Check Out This Undervalued Utility Stock

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Investors who are looking for high-yield stocks to support their income and retirement needs are often required to take on extra risk for these yields.  Some investors are prepared to do this, as they deem the risk/reward trade-off as attractive, but other investors do not want to take on added risk in their portfolios.

Thankfully, every once in a while we uncover a high-yield dividend stock trading at levels that do not seem to be warranted given the fundamentals of the company.  This is the case today with Inter Pipeline Ltd. (TSX:IPL) stock.

Inter Pipeline, a major petroleum transportation, storage and natural gas liquids processing company, whose pipelines span over 7,800 kilometers and transport over 1.4 million barrels per day, has a solid base of premium assets, a strong balance sheet, and is an investment grade utility company that is well positioned to capitalize on future growth opportunities.

Let’s review what I think makes this dividend stock a steal at these undervalued levels, and why I think we can get an 8% dividend yield without taking on the usual risks associated with such a yield.

Consistently growing funds from operations

In the last 10 years, Inter Pipeline generated funds from operations that have increased every year, for steady and reliable growth.  In fact, the growth was not only steady, but was also quite strong, with a ten-year compound annual growth rate (CAGR) in funds from operations of 8.3%.

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Strong dividend history

Inter Pipeline has a strong history of dividend growth and stability, with 14 years of dividend increases and a ten-year CAGR of 7.2%, and a five-year CAGR in dividends of 9%.   These dividend payments are comfortably made and comfortably covered, and with a payout ratio of a very healthy 60%, investors can feel secure.

Furthermore, 70% of Inter Pipeline’s EBITDA is cost-of-service and fee-based contracts, which means that cash flows are fairly predictable and reliable, lowering the risk. As well, management pays its dividends using this steady and predictable cash flows, using the commodity-based cash flows to fund growth, adding another layer of security and confidence in its dividend payments.

Growth opportunities

One growth opportunity that Inter Pipeline is investing in right now is the $3.5 billion Heartland Petrochemical Complex.  The company is currently in the process of building this complex, which will contribute approximately $450 to $550 million in EBITDA annually upon its completion in late 2021.  Importantly, this project remains on time and on budget.

Also, Central Alberta offers more growth opportunities.  Inter Pipeline is spending $82 million to expand the Central Alberta Pipeline system, an investment that will certainly pay off given the pipeline constraints that have plagued the Canadian oil and gas industry and the desperately needed relief.

Clearly, spending has been ramping up, and accordingly leverage has and will continue to increase.  The debt to total capital ratio was below 60% in 2018, but will rise to the low 60% range in the next two years.  Thankfully, interest rates remain low and the expectation is that they’ll go even lower.

Inter Pipeline stock price has fallen 33% in the last five years, which doesn’t match the company’s actual performance.  There’s still time to grab this 8% yielder for massive upside and an abundance of dividend income.

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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 Karen Thomas has no position in any of the stocks mentioned.

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