Dividend stocks can give you regular cash income, usually ranging between 2% and 5% per year. That’s already better than most bank accounts, but with dividend stocks, you also get long-term upside potential through share price gains.
Some dividend payments are rather large. Many high-yield stocks offer payments of 6% or more. While this can be enticing, it’s not without risk. Many big dividend stocks end up cutting their payments down the line, which means the initial high yield ultimately becomes a teaser rate.
Not all high-yield stocks have extra risk, however. Some business models are perfect for paying reliable dividends that lead the market. One such stock is Inter Pipeline Ltd (TSX:IPL), which offers a remarkable 8.1% dividend yield.
Let’s figure out how you can profit.
Control the space
The pipeline industry is rife with consolidation. Stocks like Enbridge Inc and TC Energy collectively control roughly $200 billion in market value. Inter Pipeline, for comparison, is worth just $9 billion.
Why are pipelines so consolidated?
The first factor is cost. Pipelines cost millions of dollars per mile to build, requiring a ton of cheap financing to construct profitably. Bigger companies are thus more likely to take on mega-projects that vastly increase their market share.
The second factor is scale. A pipeline that transports crude oil 15 miles isn’t much use. The network needs to be large enough to service multiple refineries and export terminals. The bigger the network, the more demand you’ll have, which naturally coalesces customers to a handful of operators.
Inter Pipeline recognized these barriers to entry and instead focused on a niche segment of the industry: oil sands and complementary services.
Around 15% of the company’s cash flow still comes from conventional pipelines, but another 55% stems from oil sands transportation infrastructure. These pipelines have different characteristics given the output has drastically different qualities. In a way, Inter Pipeline has cornered the market, competing mainly with integrated producers like Suncor Energy Inc.
Oil sands production often needs extra processing to reach the market due to its lower quality. Inter Pipeline has capitalized on these needs by building out massive processing facilities, including its Heartland Complex, which could add $500 million in incremental EBITDA once it’s brought online.
By focusing on oil sands projects, Inter Pipeline has been able to expand faster than expected, recently completing 11 bolt-on connections at an average cost of just 3.2 times incremental EBITDA. Management has outlined $3.7 billion in capital opportunities, $2.3 billion of which stems from its oil sands operation.
While the dividend yield appears high, the Heartland Complex should solidify its sustainability by the end of the year. Additionally, Canada is expected to increase its fossil fuel production for at least another decade, which should be music to shareholder’s ears.
Over the last decade, Inter Pipeline has raised its dividend by an average of 7.3% annually without ever cutting the payout. The dividend growth rate should slow — indeed, the annual growth rate over the last five years was only 5.3% — but underlying cash flow should have no issue supporting the current payment. When the yield is at a juicy 8.1%, slower growth isn’t a huge deal.
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The Motley Fool owns shares of and recommends Enbridge.
Fool contributor Ryan Vanzo has no position in any stocks mentioned.