Pembina Pipeline Corp (TSX: PPL) is a Canada-based transportation and midstream service provider. The company owns an integrated system of pipelines that transport various hydrocarbon liquids and natural gas products produced primarily in western Canada. It also owns gas gathering and processing facilities and an oil and natural gas liquids infrastructure and logistics business.

Revenue Mix

Source: Annual Report

Investment Rationale

• An Income Play: The year, just gone by created a landmark divide between those who sustained their dividend payment and those who did not. Pembina Pipeline falls in the first camp. The oil & gas midstream company based out of Canada has a long track record of consistent dividend payment. At the last closing price, PPL shares were featuring a lucrative dividend yield of 7.36%, which is significantly higher compared to TSX Composite dividend yield of 3.3% and Canada 10-Year Government Bond Yield of 0.70%.  Moreover, the company has maintained and grown dividend since 1999, with 60% payout ratio of ACF.

Dividend History. Source: Refinitiv (Thomson Reuters)

• Free Cash Flow Improved Significantly in Q3FY20: Free cash flow is a crucial metric since it provides the toughest criteria and captures the true impact on the financial position. PPL reported a significant jump in the free cash flow on a sequential-quarter basis. In the third quarter of 2020, the company free cash flow bolstered by ~73% as 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. Also, strategic cost measures have helped the company to bolster its free cash position.

Source: Refinitiv (Thomson Reuters)

• A Bullish Technical Breakout on Daily Price Chart: Shares of PPL registered a bullish breakout on January 05, 2020, with stock crossover the crucial near-term resistance of 20-day EMA and since then traded above it. This implies that the stock has created a new support level and moving higher. Moreover, MACD also crossover its 9-day SMA signal line and 12-day EMA is about to crossover 26-day EMA, a bullish indicator. Further, 14-day RSI is rising and hovering in a neutral zone that implies increasing buying interest in the PPL counter.

Technical Price Chart. Source: Refinitiv (Thomson Reuters)

• Discounted TTM Valuation: From the trailing twelve-month valuation standpoint, PPL shares are trading at a discount to the industry average. From TTM Price-to-Earnings (P/E) multiple standpoints, PPL shares are trading at a multiple of 21.3x, whereas industry average P/E multiple stood at 31.55x, implies a discount of ~33%. Also, from TTM Price/Cash Flow and EV/Sales multiple standpoint PPL shares are available at a discount to the industry average.

Source: Refinitiv (Thomson Reuters)

• Investment Grade Clientele and Diverse Counterparty Exposure: PPL 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. Also, non-investment grade and split-rated counterparty exposure is well diversified across various industries.

Source: Company Filing

• Key Risks Associated with Investment
• Lower Energy offtake in the global market.
• Forex risk, mainly weakness in US Dollar and Pound Sterling against the CAD
• Global macro-economic uncertainties
• Counter party default risk.
• Interest rate risk

Financial Highlights: Q3FY20

Source: Company Filing

• 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.
• Infrastructure and other services revenue reported CAD 150 million increase due to revenue contributed by the Cochin Pipeline, Edmonton Terminals and Vancouver Wharves acquired in the Kinder Acquisition, partially offset by lower interruptible volumes in Pipelines and lower capital fees in Facilities, largely due to reduced energy demand because of the ongoing COVID-19 pandemic.
• Product sales revenue posted CAD 281 million decrease 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 grew 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.
• Total volume increased 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 reported CAD 101 million decrease, 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 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. Marketed NGL volumes decreased as Pembina proactively increased storage positions with the intention to monetize them during the upcoming winter season.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 22.6% of the total shareholding. The Vanguard Group, Inc. and RBC Dominion Securities, Inc. holds the maximum interests in the company at 3.30% and 2.86%, 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 again demonstrated its stability and resiliency. The groups have diversified 200 counterparties, with approximately 75% of the company's credit exposure is with investment-grade and split-rated counterparties or with counterparties secured by letters of credit.  Non-investment grade and split-rated counterparty exposure are well diversified across various industries.

The company's free cash flow bolstered by 73% in the third quarter of FY20 on a sequential-quarter basis, led 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.

From the income-seeking investor's standpoint, PPL shares are offering a lucrative dividend yield of more than 7% amid the low-interest-rate environment. Moreover, the company's dividend has increased with a CAGR of 4.2% over the past 10-years.

Further, a bullish breakout on the daily price chart is a good entry-level for investors as it is showing technical strength in the stock.

Therefore, based on the above rationale and valuation, we have given a "Buy" recommendation at the closing price of CAD 34.22 on January 7, 2021.

1-Year Price Chart (as on January 07, 2020). Source: Refinitiv (Thomson Reuters)

Disclaimer

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