PPL:CC - Pembina: Stable Operating Cash Flow Attractive 6.4% Yield Makes The Stock Appealing

2023-09-01 12:07:34 ET

Summary

• Pembina Pipeline Corporation is a resilient midstream company in the energy industry with a diverse network of pipelines and infrastructure.
• The company's long-term contracts and stable cash flow provide stability and support for dividend payments.
• Pembina's solid cash and capital structures, along with a healthy leverage condition, make it a favorable investment option.

Introduction

Pembina Pipeline Corporation ( PBA ) is a prominent energy transportation and midstream company that provides services throughout North America's energy industry. The company's operations and network are vast and separated in hydrocarbon liquids and natural gas pipelines, gas gathering and processing facilities, oil and natural gas liquids infrastructure and logistics services, and an export terminals business. It is worth noting that in contrast to many midstream companies, Pembina's business structure makes its operations resilient from the fluctuation of commodity prices to a great extent, and this attitude is observable in its cash and capital structures. Overall, in this analysis, I investigate Pembina Pipeline Corporation's financial and business outlooks to realize if the company is a profitable investment decision.

Pembina's business outlooks

The oil and gas industry has a nature of high volatility due to various factors that may affect oil and natural gas prices. However, one noteworthy element of Pembina's financial structure is associated with its long-term contract business model . In other words, approximately 70% of the company's contracts are based on fixed fees with minimum volume commitments, which would cause consumers to receive a certain amount of resources from Pembina Pipeline's infrastructures or pay them anyway. With these take-or-pay contracts, the company can provide stability to its cash flow, thereby distributing more dividends as they are more confident about its future cash generations. In addition, an attractive element of Pembina's financial structure that makes the company appealing to income-focused investors is related to their circa 6.4% dividend yield, which is very attractive for companies in this industry (see Figure 1).

Figure 1 -

During the second quarter of 2023, wildfires in Alberta and British Columbia, Canada, affected both Pembina and its customers' operations: the Northern Pipeline system outage, which partially offset the impacts of growth and volumes of certain systems in their crude oil marketing business. Notwithstanding vast wildfires in these regions, thankfully, the company's assets did not incur damages, and thus impacts had been short-term, and they are likely to get back on the volume growth track by the end of 2023. In doing so, the management remains on their guidance of 4% higher volumes in the conventional pipeline business by the end of the current year versus the prior year. Besides conventional pipelines, Pembina's operation developments will bring more volume growth in the future to meet increasing demand in this industry. As the management stated :

"…volume growth is expected to continue through the rest of the decade based on certain industry-wide developments, including most notably, additional egress through various West Coast LNG projects and the Trans Mountain Pipeline expansion; production growth in the Montney, Duvernay, and Clearwater; and the expansion of Alberta's petrochemical industry."

Pembina's financial outlook

Analyzing Pembina Pipeline's cash structure indicates the company's healthy position to support dividend distributions. As Figure 2 illustrates, notwithstanding fluctuations in commodity prices during the recent quarters, Pembina's operating cash flow has been almost stable. In minutiae, the company generated $493 million of cash flow from the operation, which was higher than $339 million and $469 million at the end of the first quarter of 2023 and 2Q 2022, respectively. Moreover, investing in more infrastructures and projects like Phase VIII Peace Pipeline and RFS IV expansion at the Redwater Complex has brought circa $95 million of capital spending in the recent quarter. When all was said and done, they could generate approximately $400 million of free cash flow at the end of the second quarter, which was far higher than $235 million of FCF in 1Q 2023.

Figure 2 - PBA's cash structure (in millions).

Midstream companies usually hold a high amount of debt in their capital structure because they finance their investments and projects' capital spending via debt and equity financing. Regarding their project investments, Pembina is progressing approximately $300 million of smaller projects, excluding Phase VIII and Redwater IV. One of these projects is the Nipisi Pipeline, which will be reactivated during the third quarter of 2023, and another one is related to Northeast BC infrastructure expansion. It is worth stating that in the Northeast BC infrastructure, they will make terminal upgrades, more storage, and a new pump station, which are expected to be completed by the end of 2024. By providing approximately 40,000 barrels per day of incremental capacity, Pembina is capable of meeting higher demand in the future. Apart from promising higher capacity to provide growth benefits in the near future, the management has already made long-term midstream service agreements with three premier Northeast BC Montney producers for their services of liquids. These early agreements would slacken the risk of lower commodity prices and ensure the company's ability to cater to a stable operating cash flow with their new infrastructures.

Following the capital-intensive nature of companies' operations in the oil and gas industry, it is usual for these companies to hold plenty of debt. However, Pembina Pipeline has been successful in strengthening its balance sheet by declining its net debt levels to $8.4 billion in 2Q 2023 year over year compared with $9.1 billion at the same time in 2022. As I mentioned earlier, similar to other companies in this industry, Pembina Pipeline would rely on debt and equity financing to afford its capital spending, and thankfully an equity level of approximately $11.7 billion is well enough to support their balance sheet health and stability (see Figure 3).

Figure 3 - PBA's capital structure (in millions).

After analyzing Pembina's cash and capital structures, it goes with no surprise to see the leverage condition is healthy enough to cover the company's obligations. The management has had a range of 3.5x to 4.25x for their leverage ratio. Thanks to their solid financials, which led to a guidance of 3.4x to 3.6x of debt-to-adjusted EBITDA by the end of 2023. Furthermore, across the board of net debt-to-equity and net debt-to-CFO, the company illustrates a healthy leverage condition. The net debt-to-equity ratio is one of the most crucial leverage ratios for companies in the oil and gas industry, as it indicates the amount of outstanding debt that the company can pay off with its equity level. Pembina's net debt-to-equity ratio sat at 0.72x in TTM, which demonstrates its solvency and low risks. Moreover, their net debt-to-operating cash flow in TTM is 4x, which is a healthy amount for companies in this industry. All in all, Pembina's leverage condition brings no concerns regarding the company's capability to fulfill its future investments and expansions (see Figure 4).

Figure 4 - PBA's leverage ratios

Risks related to Pembina's investment

Notwithstanding major take-or-pay contracts, Pembina's operations are still exposed to commodity price volatility. Some of Pembina's transportation contracts and agreements do not include fixed-fee commitments thus, Pembina is exposed to volume risk from those contracts. Another risk associated with Pembina's operations is related to its geographical conditions. Wildfires in Alberta and British Columbia have become a crucial issue in these regions every year, causing constraints and outages for the company's operations. Although these fires did not damage Pembina's assets recently, they curbed their operations to a great extent, which may keep going. Ultimately, the higher inflation rates due to the COVID-19 outbreak, the Russian invention of Ukraine, and thus higher interest rates to combat inflation have increased the company's interest expenses considerably. The remaining high interest rates may adversely affect levels of demand for Pembina's services and cost of inputs and thus negatively impact their financial condition and cash flow operations.

Conclusion

Pembina Pipeline is one of the most prominent midstream companies in North America. The company provides a 6.4% dividend yield, which is very attractive. More importantly, their business structure based on take-or-pay contracts guarantees the company's stable operating cash flow and therefore, stability of their dividend payments. Pembina's cash and capital structures are solid and healthy, and its leverage condition is strong enough to assure the company's capability of financing its under-construction projects and expansions. When all was said and done, analyzing Pembina Pipeline's financials and business outlook, I believe a buy rating is appropriate for PBA stock.

As always, I appreciate your time and opinions.

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