Investment Rationale

• Second Quarter Results Show Strength and Stability: Pembina Pipeline Corporation announced its second-quarter 2020 results on August 6, 2020. The group saw its revenues decline, but cash flow remains much more stable. Most of the company's business was not affected by energy price volatility. Amid COVID-19 pandemic, the midstream companies have generally held up better than many other energy firms due to inherent advantages of their business models. Indeed, Pembina's results were certainly not all bad. This is something that investors should appreciate since it tells that the company is well-positioned to ride out the current weakness in the economy. Also, the group is focusing on preserving a strong balance sheet while funding its ongoing business.

• Investment Grade Clientele and Diverse Counterparty Exposure: The underlying business remains supported by significant long-term fee-based contracts, including cost-of-service or take-or-pay contracts with no volume or price risk. Approximately 75% of the company's credit exposure is with investment grade, split-rated and secured counterparties. This is something that we should find interesting because an investment-grade company is generally unwilling to break a contract due to the risk of reputational damage. Therefore, the group's contract coverage appears to be reasonably strong. This lends the group well to the type of stability an investor like to see.

Source: Company Presentation

• Offering a High Yield Income Opportunity: By investing in PPL shares, investors are likely to have an opportunity of earning approximately 7% of yield income. At the last close price of CAD 35.24 (on August 13, 2020), its shares were offering a dividend yield of 7.15%, which is significantly higher given the lower interest rate environment in the economy as the money flow is coming from the central banks in which one just cannot find a decent yield income. Therefore, this higher yield income is an attractive option for income investors who are seeking a decent yield income.

• PPL shares were trading above the crucial short-term support levels: At the last closing price, shares of PPL traded above the crucial short-term support levels of 30-day and 50-day SMAs, which is typically considered as positive price trend in the stock in short-run. Also, the moving averages are edging higher, which is another positive price indicator. Further, the Moving Average Convergence Divergence is rising and featuring above the 9-day signal line, and the difference between 12-day and 26-day SMAs is positive, which is another favorable indicator. Also, the leading momentum indicator, 14-day Relative Strength Index is hovering in a neutral zone. 

• Risks 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.

2QFY20 Financial Highlights

Source: Company filings

During the second quarter, the impact of low crude oil and NGL prices was seen through lower producer activity and a temporary decline in physical volumes in certain of Pembina's businesses. Yet, the impact to Pembina's financial results has not been as significant, as a highly contracted commercial framework, paired with broad diversification of customers and commodities, ensured a resilient business foundation even during these difficult times.

Pembina's longstanding commitment to its financial guardrails and the steps taken recently to preserve its balance sheet and enhance its liquidity is expected to allow the Company to exit 2020 in a strong financial position, ensuring its ability to restart various capital projects when it is deemed prudent to do so and providing confidence in the Company's ability to fund a stable and growing dividend.

 Source: Company Presentation

Revenue during the second quarter of FY20 slumped by 29.86% to CAD 1,268 million against CAD 1,808 million reported in a year over the period, driven by lower revenue from Pipeline and Facilities segments.

The Company's counterparties have managed well through the pandemic. The company's bills receivable stood at 97%, implies that they are paid within 30 days, and the company's counterparty portfolio is approximately 75% investment grade, secured or split-rated.

Net Income during the 2QFY20 came in at CAD 253 million, as the earnings were partially offset because of weaker global energy demand resulting from the ongoing COVID-19 pandemic. However, positively impacted by higher gross profit in Pipelines and consistent gross profit in Facilities, as the contribution from additional assets following the acquisition of and the U.S. portion of the Cochin Pipeline.

Segment Highlights

Pipelines volumes in the 2QFY20 stood at 2,555 mboe/d, 1% higher on a YoY basis, primarily driven by the contribution from the Cochin Pipeline following the Kinder Acquisition, combined with higher temporary interruptible volumes on Ruby, and partially offset by lower interruptible volumes on the Peace Pipeline system and Drayton Valley Pipeline as a result of the ongoing COVID-19 pandemic. Pipelines reported adjusted EBITDA for the second quarter of CAD 540 million, which represents a 14% increase compared to the same period in the prior year.

Facilities volumes of 872 mboe/d in the second quarter increased 1% on a YoY basis. Facilities reported second-quarter adjusted EBITDA of CAD 250 million, which represents a 6% increase compared to the same period in the prior year, as the quarter positively impacted by additional revenue from Vancouver Wharves and Duvernay II, combined with lower long-term incentive costs, partially offset by higher operating expenses related to Vancouver Wharves and the Duvernay Complex.

Marketing & New Ventures reported second-quarter adjusted EBITDA of CAD 29 million, down 60% on a YoY basis largely due to lower margins on crude oil and NGL sales.

Stock Performance

At the closing (on August 13, 2020), shares of PPL traded approximately 1.54% lower against the previous trading session at CAD 35.24. Over the last year, its shares have tested a 52W high of CAD 53.79 on February 20, 2020 and a 52W low of CAD 15.27 on March 19, 2020. At the last closing price, PPL shares have traded approximately 34.49% lower from its 52W high price level and traded approximately 130.78% above its 52W low price level. This reflects that the stock is tilted towards its 52W High price level, a positive price trend.

1-year price performance (as on August 13, 2020, after the market close). Source: Refinitiv (Thomson Reuters).

Also, the short-term price trend is favourable in the stock, as PPL shares are up by 11.10%, 8.70% and 2.17% over the last 3-month, 1-month and 5-day trading sessions. However, featuring a negative return on a YoY and YTD basis.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together form around 23.47% of the total shareholding. Vanguard Group, Inc. and RBC Dominion Securities, Inc. holds the maximum interests in the company at 3.35% and 2.67%, respectively.  Further, 8 out of top-10 shareholders have increased their stake in the company over the last three months, with Harvest Fund Advisors LLC and RBC Wealth Management, International are among the top investors in the company which have increased their stakes by 4.21 million and 2.96 million, respectively. The institutional ownership in the PPL stood at 65.96%, and ownership of the strategic entities stood at 0.20% respectively

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative) – EV/EBITDA based Valuation Metrics

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

Stock Recommendation

Amid COVID-19 pandemic, the midstream companies have generally held up better than many other energy firms due to inherent advantages of their business models. In the second quarter of FY20, PPL saw its revenues decline, but cash flow remains stable. Further, the group’s unwavering commitment to the financial guardrails means Pembina is well positioned, and the underlying business remains supported by significant long-term fee-based contracts, including cost-of-service or take-or-pay contracts with no volume or price risk.

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. Further, the group maintain a strong BBB rating with conservative balance sheet metrics and ensure ample liquidity to fund the business until market conditions stabilize. At the end of Q2FY20, the company has ample liquidity, with CAD 2.8 billion of available cash and borrowing capacity.

Moreover, its shares are offering a lucrative dividend yield of 7.15%, which is significantly higher, given the lower interest rate environment.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the closing price of CAD 35.24 (as on August 13th, 2020), with a lower double-digit upside potential, based on the NTM EV/EBITDA multiple of 11.46x, 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.

*Recommendation is valid at August 14, 2020 price as well.

*Please be aware dividend is variable and not guaranteed.

Disclaimer

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