Revenue Mix

Source: Annual Report FY19

Investor Rationale

• Pipeline Business Recorded Resilient Performance in Q3FY20: Approximately 23% of the group’s total revenue comes from the Pipeline business, which performed well in the third quarter of FY20. Gross total revenue improved by 26% on a YoY basis and gross profit expanded by 14% during the period under consideration. This was primarily driven by 140% surge in transmission revenue on a YoY basis and a 78% increase in the Oil sands revenue against the same quarter of the corresponding previous financial year. Both divisions together contribute nearly 42% in the group’s pipeline segment revenue. However, Pipeline segment revenue was slightly impacted because of 1% reduction in the group’s conventional revenue on a YoY basis.

Pipeline Segment Performance in Q3FY20. Source: Company Filing

• Facilities Segment remained Immune to Amid COVID-19 Pandemic: The group’s facilities business segment also remained immune amid the COVID-19 led pandemic, with gas service net revenue remain consistent with the prior period, and NGL Services net revenue reported growth primarily because of revenues from the Vancouver Wharves following the Kinder Acquisition. Further, adjusted EBITDA increase primarily due to the contribution from the Vancouver Wharves following the Kinder Acquisition and Duvernay II being placed into service, combined with increased revenue at Kakwa River, partially offset by lower revenue at the Resthaven facility and Cutbank Complex and lower volumes at the Younger facility.

Facilities Segment Performance in Q3FY20: Source: Company Filing

• 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 one 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 itself well to the type of stability an investor like to see.

Source: Company Presentation

• Pembina is a Cash Cow: Pembina’s shares are offering a lucrative dividend yield of 8.8%, with a track record of dividend payment over the past two decades. Though the dividend yield is slightly inflated owing to a correction in the share price amid COVID-19 pandemic. Also, amid a lower interest rate environment where Canada’s 10-Year Government Bond Yield is hovering near its life-time low, Pembina is a good opportunity to invest in a high yielding income stock with history of consistent dividend payment over the past 20-years.

Dividend Payment History. Source: Refinitiv (Thomson Reuters) 

• Risks Associated to Investment: Pembina's business is exposed to commodity price volatility, and a substantial decline in the prices of these commodities could adversely affect its financial results. Further, Pembina relies on railroads and trucks to distribute its products for customers and to transport raw materials to its processing facilities. Costs for environmental damage, damage to property and/or personal injury in the event of a railway incident involving hydrocarbons have the potential to significantly affect the performance. Also, a reduction in the current ratings on Pembina's debt by its rating agencies, particularly a downgrade below investment-grade ratings, could adversely affect Pembina's cost of financing and its access to liquidity and capital.

Financial Highlights: (Q3FY20, CAD million)

Source: Company Filing

• Infrastructure and other services revenue increase CAD 150 million due to revenue contributed by the Cochin Pipeline, Edmonton Terminals and Vancouver Wharves acquired in the Kinder Acquisition. This was partially offset by lower interruptible volumes in Pipelines and lower capital fees in Facilities, largely due to reduced energy demand on account of the ongoing COVID-19 pandemic.
• Product sales revenue declined CAD 281 million, largely due to the impact of the COVID-19 pandemic on market conditions resulting in lower crude oil prices, combined with lower marketed NGL volumes, partially offset by higher propane and butane sales prices. Additionally, market conditions compressed margins and decreased crude activities, while lower frac spreads impacted NGL margins.
• Adjusted EBITDA increased CAD 60 million, largely due to CAD 105 million contribution from the Cochin Pipeline, Edmonton Terminals and Vancouver Wharves acquired in the Kinder Acquisition, partially offset by lower margins on crude oil and NGL sales in the marketing business as a result of lower crude oil prices and frac spreads during the third quarter of 2020, and lower contribution from Alliance due to lower interruptible volumes and Aux Sable due largely to lower NGL margins and a narrower AECO-Chicago natural gas price differential, which resulted in lower revenues. Included in adjusted EBITDA is CAD 168 million (2019: CAD 183 million) related to equity accounted investees.
• Total volume (mboe/d) recorded an increase of 15 mboe/d, due to the contribution from the Cochin Pipeline acquired in the Kinder Acquisition, combined with higher supply volumes at the Redwater Complex, Duvernay II going into service and higher temporary interruptible volumes on the Ruby Pipeline, partially offset by lower interruptible volumes in Pipelines due to lower crude oil and NGL demand and a narrower AECO-Chicago natural gas price differential. Revenue volumes include 310 mboe/d (2019: 316 mboe/d) related to equity accounted investees.
• Cash flow from operating activities during the quarter under consideration declined CAD 101 million, primarily driven by the CAD 72 million increase in taxes paid, as corporate tax instalments were deferred until the third quarter of 2020 due to the COIVD-19 pandemic, CAD 53 million increase in net interest paid, CAD 31 million decrease in distributions from equity accounted investees and CAD 25 million change in non-cash working capital, partially offset by the increase in operating results after adjusting for non-cash items.
• Net revenue of Marketing segment, which is the largest contributor in the group’s top-line declined by 56% on a YoY basis due to the impact of COVID-19 pandemic on market conditions resulting in lower crude oil prices, compressed margins and decreased crude activities, combined with lower marketed NGL volumes and lower frac spreads which impacted NGL margins. With marketed NGL volumes decreased as Pembina proactively increased storage positions with the intention to monetize them during the upcoming winter season, partially offset by increased volumes at Aux Sable. Revenue volumes include 37 mboe/d (2019: 33 mboe/d) related to Aux Sable.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 23.27% of the total shareholding. The Vanguard Group, Inc. and RBC Dominion Securities, Inc. holds the maximum interests in the company at 3.31% and 2.75%, respectively. The institutional ownership in the PPL stood at 63.73%, and ownership of the strategic entities stood at 1.12%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: All forecasted figures have been taken from Thomson Reuters

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation

During the third quarter of 2020, Pembina's highly contracted business demonstrated its stability and resiliency. Earnings in the third quarter of 2020 were positively impacted by higher gross profit in Pipelines and Facilities, as the contribution from the assets acquired in the Kinder Acquisition offset weaker global energy demand resulting from the ongoing COVID-19 pandemic. Approximately 75% of the Company's credit exposure is with investment grade, split-rated and secured counterparties.

Also, the group currently anticipates its cash flow from operating activities, the majority of which is derived from fee-based contracts will be more than sufficient to meet its short-term and long-term operating obligations, capital investment requirements and to fund its dividends.

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.

Moreover, its shares are offering a lucrative dividend yield of 8.8%, with a dividend payment track record regardless of economic situations. Also, the yield is gigantically higher, given the lower interest rate environment.

Therefore, based on the above rationale and valuation, we have given a "Buy" recommendation at the closing price of CAD 28.58 on November 5, 2020.

1-Year Price Chart (as on November 05, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at November 6, 2020 price as well.

Disclaimer

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