Pembina Pipeline Corporation is a leading transporter of fuel and midstream service provider in North America. The company, through its integrated pipelines transports oil and natural gas products that are mainly produced in western Canada. Pembina owns gas gathering and processing facilities along with oil and natural gas liquids infrastructure and logistics business. Besides, it is also constructing a petrochemical facility that will convert propane into polypropylene.

Shares of Pembina Pipeline Corporation are down more than 44% so far this year. Moreover, it has corrected more than 50% from its 52-week high of CAD 53.80. The sharp decline in PPL stock provides an excellent buying opportunity with a long-term horizon.

Investment Thesis:

• Strong Liquidity Position: Pembina has a strong balance sheet and ample liquidity to face the current challenges and fund its operations. Pembina recently entered into a new CAD 800 million unsecured revolving credit facility, which will boost its exiting CAD 2.5 billion revolving credit facility.  With the addition of it, the company now has CAD 3.3 billion in revolving credit facility capacity. Pembina has CAD 2.3 billion in cash and unutilized debt facilities, which strongly boosts its liquidity position to weather the current crisis. Investors should take note that in the next two years the company has debt maturities are modest with CAD 73 million in 2020, and CAD 800 million in 2021.

• Tightly Structured Resilient Business: Pembina’s business is diversified across multiple commodities (crude & condensate, NGL, gas) with natural hedges embedded in it. 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. Pembina announced that its underlying business is highly contracted, with about 85% of its 2019 adjusted EBITDA supported through long-term, fee-based contracts. These contracts include about 62% from cost-of-service or take-or-pay contracts with no volume or price risk. Further, nearly 80% of the company’s credit exposure is with secured counter parties with investment grade balance sheet.

Diversified Commodity Exposure

• Dividend Play: Pembina has a rich history of paying higher dividends to its shareholders. In 2019, Pembina increased its dividends twice, representing the company’s ninth annual increase. Investors should note that Pembina has returned CAD 4.5 billion to shareholders in the form of dividends over the past five years. Moreover, its dividends have increased by 6.5% annually. Meanwhile, it has never reduced its dividends. Pembina’s dividends are supported through the fee-based revenue, which entails low-risk cost-of-service or take-or-pay and contracts. What it means is that the company’s dividends are not reliant on its commodity exposed business. Over the years, Pembina focused on diversification through acquisitions, which support its cash flows, in turn, dividends. Its acquisitions of Alliance, Cochin pipelines, and Edmonton Terminal storage assets, combined with its highly contracted assets have helped the company in diversifying across commodities and credit-worthy counterparties. These efforts have resulted in resilient cash flow stream, which allows Pembina to protect its dividends during downturns. Pembina’s 2019 dividends represented only about 73% of the company’s fee-based distributable cash flow, implying that its dividends are more than covered though fee-based cash flows. Given the company’s strong cash flow generating capabilities and high yield, Pembina is an ideal stock for investors seeking steady income.

Dividends and Cash Flow History (Source: Company Reports)

Financial performance:

Pembina reported revenues of CAD 7.23 billion in FY19, down about 2% y-o-y. The y-o-y decline reflected lower NGL and crude prices. However, contribution from new assets supported the top line growth. Net revenues (net revenue is defined as total revenue less cost of goods sold including product purchases) increased by 10% y-o-y to CAD 3.12 billion. Gross profit increased 5% y-o-y to CAD 2.43 billion. Operating expenses increased CAD 51 million y-o-y, reflecting higher power costs due to the increase in power pool prices and higher consumptions. Besides, increase in labour costs and higher costs of repairs and maintenance further drove operating expenses.

Pembina posted adjusted EBITDA of CAD 3.06 billion, 8% on a y-o-y basis. The y-o-y increase came on the back of benefits from new assets in the Pipelines and Facilities. Moreover, Kinder acquisition further supported the EBITDA in 2019.

The company posted earnings of CAD 1.49 billion, up 17% y-o-y. The double-digit growth in the company’s bottom line was due to the addition of new assets, Kinder acquisition, and decline in deferred tax. However, increase in operating expenses and finance costs remained a drag.

Adjusted cash flow from operating activities stood at CAD 2.23 billion, as compared to CAD 2.15 billion in 2018. The company reported capex of CAD 1.65 billion, up from CAD 1.23 billion in 2018. Total volumes increased by 2% y-o-y to 3,451 (mboe/d).

On May 2, 2019, the company announced a 5% hike in its monthly dividends to CAD 0.20 per share from CAD 0.19. Meanwhile, on completion of Kinder acquisition, the further increased its monthly dividends by CAD 0.01 to CAD 0.21 per share. In 2019, the company paid total dividends of CAD 1.32 billion, up from 1.25 billion in 2018.

Financial Highlights (Source: Company Reports)

Recent developments:

On March 18, 2020, Pembina announced a 40% to 50% reduction in its 2020 capital budget in response to the significant decline in energy prices due to the COVID-19 pandemic. The company stated that its revised capital budget for 2020 now stands between CAD 1.2 billion to CAD 1.4 billion, down from its previous guidance of CAD 2.3 billion. The reduction of CAD 900 million to CAD 1.1 billion in capital budget will not have any impact on the company’s base business and will be used to lower its leverage.

On December 16, 2019, Pembina announced that it has completed the acquisition of Kinder Morgan Canada Limited and the U.S. portion of the Cochin Pipeline system from Kinder Morgan for a total consideration of CAD 4.25 billion.

Top 10 Shareholders:

The top 10 shareholders have been highlighted in the table, which together forms around 22.8% of the total shareholding. The Vanguard Group, Inc. is the entity holding maximum shares in the company at 3.43%. RBC Dominion Securities, Inc. is the second-largest shareholder, with a holding of 2.7%

Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics:

Key Metrics (Source: Thomson Reuters)

Key Valuation Metrics:

Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodology (Illustrative): EV/EBITDA Multiple Approach 

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of PPL is quoting at CAD 26.83 with a market capitalization of CAD 14.72 Billion. PPL stock has corrected more than 44% so far this year owing to a sharp decline in the oil prices. The massive fall in PPL stock has driven its yield higher, which stood at ~9.39%. Though the company will not raise dividend in 2020, its dividend is supported through resilient cash flow stream, which will help the company in protecting dividends even during the downturns. While lower oil prices and uncertainty surrounding the economy acts as a dampener, PPL’s diversified and contracted business is likely to drive the stock higher once the economy revives. Pembina has a strong liquidity position which we believe is more than enough to meet its funding needs in 2020. Also, Pembina’s underlying business is highly contracted, supported through long-term, fee based contracts. In 2019, about 85% of its adjusted EBITDA was backed by these low risk contracts with no volume or price risk. Further, nearly 80% of the company’s credit exposure is with secured counterparties with investment grade balance sheet. We have valued the company using EV/EBITDA based relative valuation method and have taken peers like TC Energy Corp (TSX: TRP), Enterprise Products Partners LP (TSX: EPD), Inter Pipeline Ltd (TSX: IPL) to name a few and arrived at a price target that implies lower double-digit upside (in % terms). Hence, we recommend a ‘Buy’ rating on the stock at the closing market price of CAD 26.83 as on April 16, 2020.

PPL One-Year Daily Price Chart (Source: Thomson Reuters)

Disclaimer

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