One part of the Inter Pipeline (TSX:IPL) story has investors enthralled. Above all else, they care about the company’s sudden dividend cut.
It’s no surprise that a bunch of dividend investors — which have been Inter Pipeline’s core shareholder group for years now — would care about the payout above all else. After all, the company offered a consistent 8% yield for a long time. Of course, these folks were going to hit the sell button as soon as that payout was cut.
Now that the dividend cut is behind us, I’d recommend investors forget about Inter Pipeline’s payout for a second and focus on the underlying business. When we do that, we can see the company has an impressive array of assets selling at far less than replacement cost. These assets are poised to do well, assuming oil recovers from here — especially if you buy them at a cheap valuation, like today’s price.
Let’s take a closer look at Inter Pipeline’s future. I think you’ll like what you see.
Great assets
The market is deeply divided on all energy stocks, including Inter Pipeline.
In one group, we have folks who think oil is permanently impaired. They see a world where humans rapidly move away from the commodity to more environmentally friendly solutions. Some might discount this attitude, but Canadians must remember that a majority of voters just voted for federal political parties that advocated restrictions on the energy industry. This is definitely a trend.
Then there’s the other group, who accept the fact oil is a integral part of our economy and will be for years to come. In fact, many view this latest oil shock as a good thing; it means many of the marginal producers will go bankrupt. As they say, the cure for low oil prices are low oil prices. Marginal production will leave the market and then prices will go up.
If you’re in the bull camp, then Inter Pipeline is well positioned for the future. About half of its earnings come from three major pipelines that transport bitumen from the oil sands to Edmonton-area refineries. These oil sands assets have 40-50 years‘ worth of life left. In other words, they’re not going anywhere.
Another 20% of earnings come from natural gas processing, a part of the business that’s the most tied to commodity prices. Natural gas has also suffered lately, but it’s held up better than oil. The commodity also has a better long-term future as well. Nobody is arguing against natural gas.
Investors must also remember Inter Pipeline’s long-term earnings outlook remains pretty much the same as it did a few months ago. The Heartland Petrochemical Complex will still add to the bottom line in 2022. Crude will still flow from the oil sands. The dividend reduction was to free up capital to help build Heartland.
A fantastic price
If you believe Inter Pipeline’s earnings will eventually return to normal, today’s $8 share price is a screaming buy.
Remember, the company generated $2.12 per share in funds from operations in 2019. And that was significantly lower than 2018’s number, which checked in at $2.80 per share. We could easily see 2022’s earnings back to 2018’s levels once Heartland starts contributing to the bottom line.
We can also look at it a different way. Inter Pipeline has a market cap of just $3.3 billion. That’s well under replacement cost for its oil sands pipelines alone. Investors are essentially getting the other half of the company’s earnings — plus upside potential from Heartland — for free. That’s an excellent value proposition.
In other words, a pipeline trading for book value usually represents a great value, since the assets are depreciated over time. Inter Pipeline trades around 80% of book value.
The bottom line
At $8 per share, I simply can’t believe how cheap Inter Pipeline has gotten. This company could be a massive long-term winner if it returns to its previous valuation.
And remember, management rejected a $30/share takeover bid just last year. That might be a good long-term price target once things get back to normal.
