Canadian energy infrastructure stocks are having a rough go right now, as investors anticipate continued anxiety around the regulatory process for gaining approvals on new projects as well as more scrutiny from environmental and other groups around existing pipelines.
As an investor, I love this type of situation, because it allows me to pick up shares of well-run, profitable, and high dividend-paying companies on the cheap when no one else is paying attention.
The stock and the play
Enter Inter Pipeline (TSX:IPL), one of the top energy infrastructure companies in Canada. Inter Pipeline makes money by transporting oil sands as well as conventional oil via a 7,200-kilometre combined pipeline network in western Canada. In addition, it also makes money from processing natural gas liquids as well as from storing petroleum products in 23 storage terminals across Europe.
This diversified business strategy does not rely on producing oil and gas but rather transporting or storing them, which means that the company is not subject to energy price volatility.
The important question is this: is the monster 7% dividend yield sustainable? The answer is a resounding yes. Keep reading to uncover the reasons why.
Could it be a takeover candidate?
It is getting harder for medium-sized energy infrastructure players to compete in this industry, especially with the complex and time-consuming regulatory environment around pipelines. This means that a medium-sized player like Inter Pipeline is always being “looked at” by bigger players as a takeover target.
Indeed, the company reported in August that it had received an unsolicited takeover bid with a cash offer. According to some published reports, the deal value may have been around $12 billion, valuing the company at around $30 per share. At a share price of about $22 per share in August, this would have represented a juicy 36% premium.
In response to the takeover story, Inter Pipeline was quick to tell the investment community that it was not in negotiations with any company around its sale. This is because the company likely feels that it doesn’t need any outside help, especially as it sharpens focus on some key projects that will drive significantly higher cash flow.
Regardless of what actually ends up happening on the takeover front, it feels like a big industry player valued Inter Pipeline at $30 per share, which is a phenomenal proof-point for investors wanting to understand the real fair value of Inter Pipeline.
Transformational growth opportunity with the Heartland project
Inter Pipeline has recently put down a big marker of growth with its monster investment in the Heartland Petrochemical Complex, which will produce 525,000 tonnes per year of polypropylene, a high-value plastic that is widely used in the manufacturing.
This project is transformational on three levels. First, it is a $3.5 billion investment, which is the biggest in the company’s history. Second, the project creates a new and diversified cash flow stream for the company in plastics that is worth up to $500 million in EBITDA. Third, the project has strong support from the Government of Alberta in the form of $200 million in royalty credits, essentially equal to a tax credit.
All of the embedded value being created in the Heartland project make the juicy 7% dividend yield safer than it already is. However, the company doesn’t have to rely solely on that project to make yield-hungry investors happy.
Inter Pipeline is a cash flow growth machine with a 12% annual growth in funds from operation (FFO) for the last five years from 2013 to 2018. During the same period, the company raised its dividend by 5% per year, which signals that it is a prudent and perhaps conservative manager of capital.
This bodes well for its future, as it juggles future growth while satisfying income-oriented shareholders happy in the short run.
The final verdict
The company’s stock has been stuck in the $20-25 range over the last couple of years, even as its financial profile has steadily grown stronger. At these levels, the stock feels extremely reasonably priced.
Smart investors would be wise to consider a position in this stock before the Heartland project comes online or a bigger energy infrastructure player in the industry decides to attempt another company takeover.