Dividend Stock Analysis: Pembina Pipeline Corporation

Periodically, I will be posting analysis on various dividend stocks. The goal is to get a slightly deeper dive into a stock without repeating a company’s annual or quarterly reports.

Today I’m covering Pembina Pipeline.

Business Overview

Pembina Pipeline Corp. engages in the provision of transportation and midstream services. It operates through the following segment: Pipelines, Facilities, Marketing and New Ventures, and Corporate. The Pipelines segment includes conventional, oil sands and transmission pipeline systems, crude oil storage and terminalling business and related infrastructure. The Facilities segment consists of processing and fractionation facilities and related infrastructure that delivers the firm’s customers with natural gas and NGL services. The Marketing and New Ventures segment undertakes value-added commodity marketing activities including buying and selling products and optimizing storage opportunities. The company was founded on September 29, 1954 and is headquartered in Calgary, Canada.

Dividend Growth History

Pembina has grown its dividend consistently over the past 10 years. Its 3 and 5 year dividend growth rates have been 4.4% and 5.9% respectively. This year it has gone a bit longer without raising its dividend, however given the state of the energy markets that is to be somewhat expected. Over time, I’d expect them to raise their dividend as their management structure incentivizes them to pay out as much of a dividend as possible within a margin of safety.

Dividend Safety

For Oil and Gas Pipelines I typically like to use Distributable Cash Flow (DCF) to measure dividend safety. This is a non-GAAP financial metric that takes Operating Cash Flow and subtracts Maintenance Capital Expenditures. The reason we want to use DCF instead of Net Income or Free Cash Flow Payout ratios is that pipeline companies typically invest heavily, often well beyond their free cash flow, and are highly leveraged.

PBA’s 2019 free cash flow was significantly below its CapEx leading to a Free Cash Flow Payout ratio of 157% making it look somewhat risky. Their cash position dwindled as well. However, earlier this year they raised a significant amount of debt to enhance their cash and allow them to operate their pipelines while reducing some of their Cap Ex.

Unfortunately I couldn’t find where PBA breaks out Distributable Cash Flow in their financials so we are left with Free Cash Flow as the best proxy for dividend safety. At this point it better than many other pipeline companies. For example here are some of the 2019 FCF payout ratios for three other pipelines that I own:

EPD: 187%

MMP: 239%

ENB: 344%

Valuation

I like to use the Dividend Discount Model to value mature dividend paying companies. My preference is to use Finbox to automatically model companies. Below is a screenshot of the valuation for PBA.

Finbox has PBA as significantly undervalued in this model. Energy as a whole has been entirely beaten down on valuations. I’m expecting a lot of consolidation in the industry as the cyclicality in energy typically leads to booms and busts.

Another way to look at dividend stocks is to look at their yield history. Currently PBA is trading at a significant discount to its prior Price to Yield. Given the cash flow problems that they’ve shown however, the discount seems to be warranted. On the other hand, once the glut of oil and gas starts to stabilize, I’d expect margins to eventually improve.

Summary

Pembina is an interesting monthly paying pipeline that I may end up investing in. Energy is still a huge factor in our economy and they are still well positioned to continue pushing oil and gas through their infrastructure. I’d say at this point that it is a speculative bet, but they appear to be well positioned to get through this energy trough and continue growing over time.

No position on my end but I’ll continue watching.

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