CA - Pembina Pipeline: Preferreds Deliver Fantastic Returns Where To Go Next

2023-12-05 20:28:07 ET

Summary

• Pembina Pipeline Corp. delivered solid Q3-2023 results, beating consensus and increasing its adjusted EBITDA guidance.
• Management expressed confidence in the 2024 outlook and prioritized debt reduction in its capital allocation plan.
• We examine the setup on the common and high yielding preferred shares.

On our last coverage of Pembina Pipeline Corp. ( PBA ), ( PPL:CA ), we gave it one of our unicorn buy ratings. While the headwinds from risk-free interest rates were still front and center, the valuation was beyond compelling and we felt that it would be able to navigate these challenges. PBA rose to the challenge and delivered 7% plus outperformance versus the broader S&P 500 ( SPY ).

We update out outlook based on the Q3-2023 results and also tell you which preferred shares now look the most attractive.

Q3-2023

PBA delivered solid results once again with an adjusted funds from operations (AFFO) of $1.20 which was 12% over Q3-2022 levels and a slight beat to consensus of $1.19. All segments did well and management increased its 2023 adjusted EBITDA guidance to $3.8 billion (midpoint). This is a pretty nice bump and explains a lot of the stock movement. Investors might recall that PBA had gone slightly in the other direction post Q2-2023.

Management changed its adjusted EBITDA guidance range to $3.55 billion-$3.75 billion, which was a slight narrowing of the range.

Source: 10% Plus Yields From Quality Midstream Player

Over the last year, cost overruns and delays have generally plagued the midstream space. In this regard, it was very helpful to hear the commentary on the construction of the Phase VIII Peace Pipeline expansion.

On the major project front, we continue to progress our Phase VIII Peace Pipeline expansion and our RFS IV expansion at the Redwater Complex. Most notably, the Phase VIII project capital budget has been revised lower by $55 million to $475 million. The revised cost reflects highly effective project management and execution, favorable weather conditions, and productive contractor relationships. We will continue to bring new pump stations into service before year-end and expect the pipeline to be in service in the first half of 2024. Our experience with Phase VIII is another example of supporting Pembina's track record of strong project execution. And we continue to progress our Cedar LNG project with our partner, the Haisla Nation.

Source: PBA Q3-2023 Conference Call Transcript

Management expressed confidence in the 2024 outlook, driven by additional volumes coming online. TMX divestiture was also touched upon, though that was most likely a late 2024 event. We don't see that as a huge market moving event in any case. The capital allocation plan was once again towards debt reduction rather than doing anything silly when interest rates have been a broad headwind.

Outlook & Valuation

With a firm commitment to living within its means and rather flawless execution (despite some wildfire related challenges), PBA is poised to reach one of the lowest debt to EBITDA multiples in its history. We project 2024 could come in the range of 3.0X - 3.2X. It is hard to find anything close to that for midstream investments. Enbridge Inc. ( ENB ), ( ENB:CA ) was at 4.1X in the most recent quarter, but that was thanks to pre-funding the equity portion of its Dominion Energy Inc. ( D ) acquisition. ENB is likely to maintain a 4.5X to 5.0X debt to EBITDA ratio in the medium term.

TC Energy Corp ( TRP ) ( TRP:CA ) is comfortably over 5.0X, though it has committed to moving below it over the next 2 years. Keyera ( KEY:CA ) is one in the ballpark with a 3.5X number. On the US side, Enterprise Products Partners LP ( EPD ) is one that holds the 3.0X mark, but the rest average close to 4.0X. Coupled with this, PBA's price to AFFO multiple is now at 9.0X when we look at 2024 numbers. This is about in line with ENB and KEY, though a bit higher than TRP. It is hard here not to get excited about these, even taking into account the price appreciation. The self funded model is the right one here and PBA is showing the same discipline it did when it walked away from the Interpipeline purchase with a boatload of cash. We continue to believe this is a "Buy" and think that we will eventually see at least a 10X AFFO multiple.

Preferred Shares

On our last update we were pounding the table for Pembina Pipeline Corporation PFD 5 YR CL A 1 (TSX: PPL.PR.A:CA )

Their current yield is almost irrelevant as they are supposed to reset by December 1, 2023. Generally, the reset itself is announced 30-60 days prior. So we are rapidly approaching the October 1-November 1 window for the same. The reset will be at GOC-5 plus 2.47%. With the current yields of 4.28%, you are looking at 6.75% on par. With PPL.PR.A trading at $17.47 you are locking in 9.66% for the next 5 years assuming interest rates stay the same. That is an extraordinary amount for the level of safety that PBA offers.

Source: 10% Plus Yields From Quality Midstream Player

These shares have even outpaced the common shares and delivered a scintillating 60% annualized return since then.

These were reset to 6.525% on par ($25).

The annual dividend rate for the Series 1 Shares for the five-year period from and including December 1, 2023, to, but excluding, December 1, 2028, will be 6.525 percent, being equal to the five-year Government of Canada bond yield of 4.055 percent determined as of today plus 2.47 percent, in accordance with the terms of the Series 1 Shares.

Source: Pembina

That means that the annual dividend will be $1.63125 and those that acted on our last alert, locked in 9.33% yield on their cost for the next 5 years. At the current price though, PPL.PR.A shares are less appealing for a 8.16% yield. With the considerable rally across the preferred share space, pickings are a bit slim. We did highlight one quality preferred play f rom another company recently, but in general, the reset type preferreds have lost some of their shine. With PBA we think another rally in the GOC-5 yields could make the next in-line to reset, a bit more attractive. Pembina Pipeline Corporation cumulative redeemable rate reset class A preferred shares series 5 ( PPL.PR.E:CA ) reset in June 2024 (current yield 6.1%) at GOC-5 plus 3.00%. At current prices ($18.75) and current rates (3.50% for GOC-5), these would yield 8.65%. If yields rise as we anticipate, we could see these locking in 9% plus for the next 5 years after that. That would be our preference if we had to select one today, but in general there are less opportunities and we would wait for credit spreads to widen before picking some preferred issues.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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