Company Profile

Pembina Pipeline Corp (TSX: PPL) is a Calgary, Canada-based midstream service provider and engaged in the business of Oil & Gas Transportation. PPL owns an integrated system of pipelines that transport oil and natural gas products mainly in western Canada. It also owns gas gathering and processing facilities and an oil and natural gas liquids infrastructure and logistics business.

Investment Rationale:

• An Income Play: PPL is offering a lucrative dividend yield of 7.72% to the investors, which is significantly higher given the falling interest rate environment across the board. Moreover, it has a consistent track record of dividend payment, and between 2000 to 2020, the company’s dividend has been increased with a CAGR of 4.9%. This is the single strongest fundamental measure from an income investor’s standpoint, as bond yields are shrinking very quickly given the uncertainty emerged in the speculative asset classes because of COVID-19 pandemic. Therefore, companies which have a consistent track record of dividend payment regardless of economic cycles is likely to be in the limelight for the income investor’s community given their higher dividend yield. Further, PPL’s dividend yield is approximately 14.3 times higher against the Canada 10 Year Benchmark Bond Yield is at 0.54% and 2.04 times of the TSX 300 Composite Index.

Source: Refinitiv (Thomson Reuters)

• Balance Sheet Strength: The company’s debt-to-equity ratio stood at 0.67, with long-term debt to total capital ratio at 38.5%, which is relatively lower against the industry median debt to equity ratio of 0.81. However, long-term debt to total capital ratio is comparatively higher than the industry median of 36.1%, but within manageable range. The interest coverage ratio of the company stood at 6.89x, which implies the company’s EBITDA is significantly higher to cover its interest expenditure. Further, the debt service to normalised net income ratio of PPL stood at 34.4%, which shows the ability of the company to pay its debt. Also, the company has ample liquidity with CAD 2.5 billion of available cash and borrowing capacity. The company has a strong credit rating of BBB by both S&P and DRBS.
• Diversified Business Model: Pembina’s business is diversified across multiple commodities (crude & condensate, NGL, gas) with natural hedges embedded in it. Owing to the diversification, the company continues to make money irrespective of the commodity cycle. For instance, when the prices of commodities are high, its crude & condensate business makes money through pipelines (higher volumes) and marketing. Meanwhile, when the prices are low, the segment generates revenues through storage and marketing services. Similarly, its NGL business makes money through LPG exports, storage, and petrochemicals when the commodity price is low. Besides, Pembina’s underlying business is supported by long-term fee-based contracts that include low risk take-or-pay and cost-of-service contracts.
• Risk Associated to Investment: A further slump in the oil and gas demand could dent the operations of midstream companies. As coronavirus cases sill moving higher, a potential near term demand distortion could be witnessed. 

Financial Highlights: Q1FY20

Source: Company Reports

During the quarter under consideration, PPL reported net revenue of CAD 865 million was approximately 11.8% higher against the net revenue of CAD 774 million reported in a year-over period. This was driven by a relatively higher total volume of 3,508 mboe/d as compared to the 3,403 mboe/d reported in the same period of the corresponding financial year.

Gross profit expanded by 23.8% to CAD 728 million, while adjusted EBITDA improved to CAD 830 million, 7.4% higher on a YoY basis against CAD 773 million reported in the first quarter of the FY19.

PPL reported earnings of CAD 314 million for the Q1FY20, was broadly in line with the earning of the same period of the corresponding financial year. The earnings were driven by higher gross profit in both pipelines and facilities post addition of assets following acquisition of Kinder Morgan Canada and the U.S. portion of the Cochin Pipeline. The constant performance of other assets further provides support to the bottom line.

PPL’s cash flow generated from operating activities during the quarter under consideration stood at CAD 410 million was approximately 33% lower against the same period of the previous financial year, driven by an increase in the company’s tax expenditure, change in non-cash working capital and reduction in the distributions from equity-accounted investees. However, this was partially offset by improved operating performance.  On per share basis, cash flow from operating activities declined by 38% as compared to the same period of the corresponding financial period, due to the aforementioned factors.

Segment Highlights

Pipelines: In the first quarter, PPL’s Pipelines business volume increased by 5% to 2,629 mboe/d on a YoY basis, supported by contribution from the Cochin Pipeline following the Kinder Acquisition and partially offset by lower volumes on the Alliance Pipeline due to a narrower AECO-Chicago natural gas price differential. EBIDTA surged by 20% on YoY basis, supported by higher quarterly revenue realised from Cochin Pipeline and Edmonton Terminals following the Kinder Acquisition combined with increase in the volume.

Facilities: Volume in this segment narrowed by 2% on a YoY basis to 879 mboe/d, on account of lower supply volumes at the Redwater Complex given the prevailing market circumstances, combined with decreased volumes at the Cutbank Complex. EBITDA improved by 10% on a YoY basis driven by additional revenue from Duvernay II, Vancouver Wharves and the Redwater Co-generation Facility, combined with lower power costs in the gas services business, however partially counterbalanced by lower revenues at the Cutbank Complex and higher operating expenses related to Vancouver Wharves.

Marketing & New Ventures: NGL sales volume reported a contraction of 10% on a YoY basis, as volume adversely impacted by a lower supply volume at the Redwater Complex, partially offset by increased volumes at Aux Sable. EBITDA slumped by 55% on a YoY basis, primarily driven by lower margins on crude oil and NGL sales as a result of the sharp decline in commodity prices during the first quarter of 2020, combined with a lower contribution from Aux Sable due to the narrower AECO-Chicago natural gas price differential and NGL prices.

Stock Performance

On June 26, 2020 (at the time of writing report) shares of PPL were trading approximately 1.7% lower at CAD 32.91. In a year over period, PPL’s shares have tested a 52W high of CAD 53.79 as on 20-Feb-2020 and a 52W Low of CAD 15.27 as on 19-March-2020. At the current price of CAD 32.91, its shares traded approximately 37% below its 52W high price level and approximately 119% above its 52W Low price level. This reflects that at the present trading level, the stock is more tilted towards its 52W peak level, which is a favourable trend given the challenging marketing conditions.

1-year price performance (as on June 26^th, 2020, before the market close). Source: Refinitiv (Thomson Reuters).

The stock has corrected 30.2% in last one year and 30.4% YTD; however, it has generated a return of ~7% in the last three months.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 23.16% of the total shareholding. The Vanguard Group, Inc. and RBC Dominion Securities, Inc. holds the maximum interests in the company at 3.35% and 2.67%, respectively. The institutional ownership in the PPL stood at 63.91% and ownership of the strategic entities stood at 0.20%.  Further, out of 10 top institutional investors, 8 has increased their stake in the period ended on March 31^st, 2020, with RBC Wealth Management, International and Harvest Fund Advisors LLC raised their stake by 2.96 million and 4.21 million, respectively.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology

Note: All forecasted figures have been taken from Thomson Reuters.

Stock Recommendation: Despite a challenging quarter led by COVID-19 pandemic, the group’s performance in the Q1FY20 ended on March 31st, 2020 was modest, with record first-quarter adjusted EBITDA of CAD 830 million. Further, the company has strong liquidity with CAD 2.56 billion available in cash and borrowing capacity, which seems sufficient to pass through the challenging market condition. The outstanding debt is also quite manageable given the debt service to normalised net income ratio of PPL stood at 34.4%, and an interest coverage ratio of 6.89 times.  Also, the PPL’s free cash flow yield 5.2% is significantly higher and shows the company’s ability and business model to generate cash flow.

Further, the company’s underlying business is supported by significant long-term fee-based contracts, including cost of services or take-or-pay contracts with no volume or price risks. Also, the company is offering an attractive dividend yield of 7.72%, which is significantly higher, given a lower interest rate regime.

Therefore based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the current price of CAD 32.91 (as on June 26, 2020), with a lower double-digit upside potential, based on the NTM Peer Median EV/EBITDA multiple on the FY20E EBITDA. We have considered TC Energy Corp (TSX: TRP), Inter Pipeline Ltd (TSX: IPL) and Keyera Corp (TSX: KEY) etc., as a peer group for the comparison purpose.

Disclaimer

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