TFSAs are on the rise.
For more than a decade, these accounts have been the fastest and easiest way to protect your capital from taxes. With flexible contribution and withdrawal rules, it’s a no-brainer to invest with a Tax-Free Savings Account. Yet for some reason, millions of Canadians neglect to sign up for one.
This year, we received good news. According to research from Bank of Montreal, two-thirds of all Canadians now have a TFSA. That still leaves out millions of Canadians, but it’s progress.
Yet TFSA holders don’t always maximize their benefits. The biggest sin is holding the wrong securities. A double-digit percentage of Canadians, for example, hold cash in their TFSAs, earning them minimal interest. By capping their gains, these investors also limit their tax protections.
Fortunately, you don’t need to hold cash to earn interest on your money and protect your downside. For a bit of extra risk, you can earn 10 times the amount of interest you’d earn with cash and still mitigate your risk in the event of a recession.
Canadian pipelines are the answer
Pipelines are great businesses to own for two reasons.
First, they’re incredibly expensive to build. According to an analysis by the Oil & Gas Journal, the average cost of a U.S. gas pipeline in 2016 was $7.7 million per mile. That’s up from $3.7 million per mile in 2009. High construction costs are bad for new entrants, but lucrative for existing operators, as they help to prevent competition.
Second, pipelines can maintain impressive pricing power, especially in Canada, where energy markets have been starved of adequate pipeline capacity. Because alternatives like rail and truck are significantly more expensive than pipelines, Canaccord Genuity Group Inc analyst Martin Roberge thinks “a lack of transportation options should allow pipeline operators to maintain pricing power.”
This pipeline stock delivers
High barriers to entry combined with strong pricing power leads to generous free cash flow generation for well-managed pipelines. Inter Pipeline Ltd (TSX:IPL), for example, offers a 7.7% dividend yield. That’s an impressive payout, but it didn’t stop management from bumping up the dividend rate last November.
With a 7.7% dividend, a $45,000 investment would net you $3,465 per year in cash payments. If you invest with a TFSA, these dividends are completely tax free.
What makes Inter Pipeline’s payout so reliable? Around 83% of the company’s cash flow comes from cost-of-service or fee-based contracts. This essentially means the underlying pricing mechanisms are not based on commodity prices. That’s good news considering oil and natural gas prices can be volatile.
The proof of Inter Pipeline’s stability is written in its history. At the end of 2012, when oil prices were above US$100 per barrel, Inter Pipeline stock traded at $22. Today, oil prices are between US$60 and US$70 per barrel, yet Inter Pipeline’s stock remains at $22.
Achieving a stable share price as oil prices collapse by 30% to 40% is impressive for any energy-related company. Paying a consistent high-single-digit dividend along the way is simply remarkable.
Whether you want to compound for capital for retirement or wish to create a sizable passive income stream, Inter Pipeline is an ideal selection.
