CA - Pembina Pipeline: Q4 Delivers Much Of The Same Plus A New Growth Project

Summary

• Pembina Pipeline's Q4 results generally showed the stability that we have come to expect for this company.
• The company's revenues primarily come from long-term contracts that promise stability regardless of economic conditions or other factors.
• The company completed Phase IX of the Peace Pipeline Expansion Project during the fourth quarter, setting it up for growth in Q1 2023.
• The company announced a new project that will expand the capacity of its giant Redwater NGL fractionation complex by 2026.
• The current dividend looks to be quite sustainable based on its current cash flow.

On Thursday, Feb. 23, 2023, Canadian midstream giant Pembina Pipeline Corporation (PBA) announced its fourth quarter 2022 earnings results. These results generally continued the recent trend that we have been recently seeing of midstream companies reporting stronger results than in the prior-year quarter. Pembina Pipeline beat the expectations of its analysts in terms of revenue and posted mild growth, although the market has not been particularly impressed with the company's performance as the stock price is down over the past week:

This weakness may not be entirely a reaction to the company's earnings results as crude oil prices have also gone down over the past week. As I have pointed out in the past, Pembina Pipeline's financial performance is not directly linked to crude oil prices. The stock does tend to trade with a correlation to the commodity, though. In fact, the company's results generally show a great deal of stability along with forward growth potential, which is exactly what we expect from this company. Pembina Pipeline has earned its place as a core holding in any income investor's portfolio and it continues to deserve this reputation.

Earnings Results Analysis

As my long-time readers are no doubt well aware, it's my usual practice to share the highlights from a company's earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Pembina Pipeline's fourth-quarter 2022 earnings results:

• Pembina Pipeline brought in total revenue of CAD$2.699 billion in the fourth quarter of 2022. This represents a 5.43% increase over the CAD$2.560 billion that the company reported in the prior-year quarter.
• The company reported an adjusted EBITDA of CAD$925 million in the reporting period. This represents a 4.64% decline over the CAD$970 million that the company reported in the year-ago quarter.
• Pembina Pipeline announced the expansion of its Redwater fractionation facility in Alberta, Canada. The company will be investing CAD$460 million to add an additional fractionation train that will be capable of processing 55,000 barrels per day of natural gas liquids.
• The company switched to a quarterly dividend from its previous monthly one, as was expected. The new dividend will be CAD$0.6525 per common share to be paid on March 31, 2022.
• Pembina Pipeline reported a net income of CAD$243 million in the fourth quarter of 2022. This represents a significant 203.75% increase over the CAD$80 million that the company reported in the fourth quarter of 2021.

As stated in the introduction, crude oil prices have been somewhat weak over the past week. This is a continuation of the general decline that we have been seeing since the middle of 2022 as recession fears and monetary tightening by various central banks have been applying downward pressure on prices. However, crude oil prices in the fourth quarter of 2022 were still somewhat higher than in the same period of 2021:

However, crude oil prices do not have a particularly large impact on Pembina Pipeline's financial performance, even though the company's stock price performance does tend to correlate with crude oil prices. This is because of the business model that Pembina Pipeline uses. In short, the company enters into long-term (usually five to 10 years in length) contracts with various customers. Under the terms of these contracts, Pembina Pipeline provides transportation for crude oil, natural gas, and natural gas liquids for its customers. The customer then compensates Pembina Pipeline based on the volume of resources transported, not on their value. This business model obviously provides the company with a great deal of insulation against fluctuations in energy prices. Approximately 80% of the company's revenue comes from these contracts:

This is nice for us as income investors due to the stability that it provides. This is not only because these contracts provide the company with protection against resource price changes. After all, one thing that we frequently see when energy prices is that upstream producers tend to cut back on their production. We saw this happen back in 2020 when crude oil prices fell, and this was one of the big reasons for the supply shortage back in 2021 that spiked energy prices. As Pembina Pipeline's revenue is dependent on volumes transported, such a production cut could be expected to reduce the company's revenue since fewer resources would need to be transported. However, the company has a way to protect itself against this as well. This comes from the fact that Pembina Pipeline's contracts contain minimum volume commitments, which specify a certain minimum volume of resources that must be sent through the company's infrastructure or paid for anyway. This provides a baseline level of revenue and, most importantly, cash flow that provides a great deal of support for the dividend. This is exactly the thing that we appreciate in an income investment. We can see the overall stability provided by this model above in the fact that the company's financial performance did not vary very much compared to the prior-year quarter despite the different resource price environment.

Naturally, as investors, we want more than mere stability. We want to see growth, which Pembina Pipeline is quite well positioned to deliver. As stated in the highlights, the company recently unveiled a CAD$460 million expansion to its Redwater fractionation complex. Pembina Pipeline's Redwater fractionation complex located in Redwater, Alberta, Canada, is one of the largest natural gas liquids fractionation facilities in Canada:

It's currently capable of processing approximately 200,000 barrels per day of natural gas liquids. Fractionation is the separation of natural gas liquids into various components, such as propane, butane, ethane, and so on. As such, it's a critical part of the value chain in getting these products from the producer to the end-user. As I mentioned in a previous article , the demand for these products has been growing. This is especially true for propane, which is used for space heating and cooking in rural areas that lack natural gas distribution infrastructure, and ethane, which is used in the manufacture of various plastics and polymers. Pembina Pipeline mentioned this growing demand in its earnings press release, which prompted the company to begin work on expanding the capacity of the facility. The company announced that it will be spending CAD$460 million to add a new fractionator to the complex. This new fractionator will add approximately 55,000 barrels per day of natural gas liquids processing capacity to the facility, bringing its total capacity up to 255,000 barrels per day when this project is complete. This project is expected to be complete during the first half of 2026 so we will, unfortunately, need to wait a few years before we really see the impact on the company's financial performance. It's nice to see that Pembina Pipeline has some long-term growth projects, however, this project will be in addition to the projects that Pembina Pipeline has been working on for some time like the Peace Pipeline Expansion Project.

One of the nicest things about the Redwater expansion is that Pembina Pipeline already has secured contracts with its customers for the use of this new capacity. This is nice because we can be certain that the company is not spending an enormous amount of money to construct fractionation infrastructure that nobody wants to use. It also means that Pembina Pipeline has a reasonable idea of how profitable the new fractionation train will be and that it offers a sufficient return to justify the initial investment. The company, unfortunately, did not state what its expected return is in the earnings release but projects like this usually pay for themselves in about four to six years. That's probably a reasonable guess for the return here, but we do not know this for certain.

During the fourth quarter, Pembina Pipeline completed work on two of the growth projects that we discussed in previous articles on the company. These are the Empress Cogeneration Facility and Phase IX of the Peace Pipeline Expansion Project. The Empress Cogeneration Facility was a bit of an unusual project for Pembina Pipeline as it was simply a natural gas power plant providing power to an existing natural gas liquids extraction plant. This was not really much of a growth project, although it may reduce the company's costs a bit. Phase IX of the Peace Pipeline Expansion Project, meanwhile, was certainly a growth project as it increases the capacity of natural gas liquids pipelines moving hydrocarbon products through the corridor north of Gordondale, Alberta, Canada:

As the new pipelines added through this project began operating during the fourth quarter, we do see some of this project's impact on Pembina Pipeline's fourth quarter results. However, there will be a larger impact during the first quarter of 2023 because the project will have operated for the entire quarter as opposed to simply part of it. This should therefore provide a bit of growth during the first half of this year.

Dividend Analysis

As stated a few times throughout this article, Pembina Pipeline has been a core holding for income-focused investors for many years now. This is due to the company's historically high yield, financial stability, and its monthly dividend that allowed for rapid compounding. Unfortunately, as I discussed in my last article on Pembina Pipeline, the company abandoned its monthly dividend payment schedule starting in 2023. That's disappointing, particularly for those who are depending on the company for money to pay their bills and other monthly expenses. It also means those people that reinvest the dividends will not enjoy as rapid compounding as in the past. However, the new quarterly schedule puts the company in the same boat as pretty much every other midstream energy company so it's not really the end of the world. In conjunction with its fourth quarter earnings release, Pembina Pipeline announced a CAD$0.6525 per share quarterly dividend, which is in line with the dividend that it paid from September 2022 until December 2022, although it's higher than the monthly dividend that Pembina Pipeline was paying prior to that date:

This continues a long string of annual dividend growth for the company and gives the company a 5.35% yield at the current price. This is quite appealing during inflationary times, such as the one that we are experiencing today. After all, inflation is constantly reducing the number of goods and services that we can purchase with the dividend that the company pays out. This can make it feel as though we're getting poorer and poorer with the passage of time. The fact that Pembina Pipeline increases the amount that it pays out every year helps to offset this effect and maintains the purchasing power of the dividend.

As is always the case though, it's critical that we ensure that the company can actually afford the dividend that it pays out. After all, we do not want to be the victims of a dividend cut since that would both reduce our incomes and likely cause the share price to decrease.

The usual way that we judge Pembina Pipeline's ability to maintain its dividend is by looking at its operating cash flow. This is because the company's finances look much like a utility as its volume-based contract business model delivers the same sort of stability that we expect from utility companies. During the fourth quarter of 2022, Pembina Pipeline had an operating cash flow of CAD$947 million. That works out to CAD$1.72 per common share. As the company only pays out $0.6525 per common share, it obviously has more than enough cash flow to cover the dividend with a great deal of money left over for other purposes. Overall, it should not have any particular difficulty maintaining the dividend at the current level. There's little reason for us to worry at this time.

Conclusion

In conclusion, Pembina Pipeline's most recent results delivered the general stability that we have come to expect from this company. Its volume-based contracts account for most of its revenue and this provides a great deal of protection from outside factors. We also see that the company completed work on two of the projects that we have been discussing over the past two years, which positions it to deliver growth in the first half of this year. Its newly announced Redwater fractionation expansion should allow the company to continue to deliver forward growth, although it will not come online until 2026. In fact, the only disappointing thing here is that the company switched to a quarterly dividend payment schedule, but we were expecting that, and it's not really the end of the world. Overall, the company continues to look like a solid core holding for any income investor.

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