Income Investors: Why Inter Pipeline (TSX:IPL) Can Continue to Grow its 7.8% Dividend

Inter Pipeline Ltd (TSX:IPL) has an attractive dividend that should continue to grow into the future.

Pipeline companies, when everything is running smoothly, are almost always great investments. This is because they are built only when demand is needed. The contracts usually lock in solid cash flows for lengthy periods of time. Additionally, the nature of the industry gives existing operators a competitive advantage as there are high barriers to entry. Inter Pipeline (TSX:IPL) is one of the best and most attractive opportunities.

Inter Pipeline is a well-run, well-diversified company. Its main areas of business are in oil sands transportation and conventional pipelines. Oil sands transportation primarily ships the products coming from the oil sands area, down to terminalling hubs in Edmonton. The Conventional pipelines consist of three main lines, the Mid-Saskatchewan, Bow River, and Central Alberta. Together, these three lines make up more than 3,900 km.

A large percentage of business also comes from NGL processing. The company processes natural gasses to separate NGLs and to produce related products such as ethane and propane. Although this is a large chunk of business, it is also a higher-risk segment, as approximately 84% of revenue is tied to commodity prices.

Inter Pipeline also has bulk storage facilities across Europe. These facilities are located in strategic areas, giving the company the ability to ship train, ship, trucks, or pipelines. The storage areas are also located near refineries and other production facilities for ease of access. Across 23 terminals, the company is capable of storing 37 million barrels.

An investment in Inter Pipeline is predominantly a play on the future of the oil sands. A lot of Inter Pipeline’s growth projects are tied to future or existing oil sands projects. This relies on capital spending by the major players in the region. The major benefit is that Inter Pipeline has the capacity available. Currently capacity on the pipeline is less than 30%, which means in time Inter Pipeline could more than triple the capacity of the line. Therefore, any additional volume it takes on will have minimal costs associated resulting in large cash flows.

The large dividend is also a key feature for investors. At 7.8%, it is significantly higher than pipeline peers. However, the dividend relies on growth projects coming to fruition. This is clear since the payout ratio is over 100%, paying out $1.71 compared to an EPS of $1.52. Although the dividend has almost no correlation with the price of oil, it’s not exactly stable either, until the payout ratio can move back below 100%.

Funds from operations (FFO) have been growing rapidly of the last five years. On a per-share basis, FFO has grown at an 11.3% compounded annual growth rate (CAGR). Going back 10 years, that number is still impressive at a CAGR of 8.3%. This has driven the dividend growth with a CAGR of 5.3% over the last five years and 7.3% over the last 10. This track record is very impressive and somewhat reassuring considering additional FFO growth will have to continue to sustain the dividend.

Inter Pipeline is a company with a history of solid performance. Both from an operations standpoint and in terms of the dividend, the company has been growing exceptionally well. The future success of the company relies on its ability to continue to grow FFO and keep the dividend sustainable. If management is able to do this, the stock is definitely worth having a look at.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Daniel Da Costa owns shares of INTER PIPELINE LTD.

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