Dividend Investors: Run, Don’t Walk, Away From This 29%-Yielding Energy Name

Low commodity prices and an expensive crown-jewel project mean a cut is on the table for this once dividend superstar.

Names that were once favourites of income investors are now brandishing massive yields thanks to the coronavirus-induced selling. While I’m all for a nice dividend, if it seems too good to be true, it’s best to err on the side of caution. Given the deterioration of its fundamentals, the following dividend superstar is at risk of a cut.

Inter Pipeline

Even before the selling picked up steam, Inter Pipeline (TSX:IPL) was already paying out a yield north of 7%. Now, two months later, the stock is trading at 2008 prices with a monthly dividend of $0.1425 — an annualized yield of 29%!

History has shown that payouts this large do not last, as companies will often cut or suspend such a cumbersome use of precious cash flow. This case is no exception for three primary reasons.

Firstly, IPL is heavily exposed to commodity pricing in its natural gas business segment, translating to 13% of 2019 company-wide EBITDA. With natural gas trading in the $2 range, while propane continues to trend downward due to chronic oversupply, IPL’s margins on the processing of natural gas to natural gas liquids continues to deteriorate, and with it, its free cash flow generation.

Secondly, natural gas is not the only commodity headwind the company is facing. As we all know, the bloodbath in oil continues, with Western Canadian Select trading at all-time lows of about $11 per barrel as of writing.

The reason why even a transporter like IPL will feel the strain of rock-bottom oil prices is because most the company’s pipeline contracts are renewed every 30 days (or less). With oil at an unsustainable level, and Alberta’s production limit to be extended to December of this year, IPL faces a very high level of counterparty risk and loss of those precious pipeline contracts.

With pipelines responsible for $168 million out of $873 million in total funds from operations, cash from this segment is critical to the viability of its dividend.

Finally, IPL’s crown jewel is its $3.5 billion Heartland Petrochemical project, which will be IPL’s hedge against the previously mentioned multi-year-low propane prices. Once buildout is complete, IPL hopes to use the facility to convert propane into polypropylene — a polymer found in clothing materials, medical products, and plastics.

For IPL, Heartland is an all-hands-on-deck project and will deliver $450-$500 million in annual EBITDA upon completion in 2021. Given the importance of Heartland on IPL’s capital budgeting decisions, it’s easy to surmise that the board will choose it over sustaining the dividend, particularly as IPL’s debt remains at a lofty six times its 2019 EBITDA.

The bottom line

Don’t be fooled by the giant yield and stay away from IPL until there is better clarity on the direction of oil prices or once the dividend has been shed. Given the current industry backdrop, it is not in the best interests of the company nor its shareholders to keep such an unsustainable cash burden. There are safer dividend names to choose.

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 Victoria Matsepudra has no position in any of the stocks mentioned.

More on Dividend Stocks

Train cars pass over trestle bridge in the mountains
Dividend Stocks

Is CNR Stock a Buy, Sell, or Hold for 2025?

Can CNR stock continue its long-term outperformance into 2025 and beyond? Let's explore whether now is a good time to…

Read more »

coins jump into piggy bank
Dividend Stocks

The Smartest Dividend Stocks to Buy With $500 Right Now

These top dividend stocks both offer attractive yields and trade off their highs, making them two of the best to…

Read more »

Middle aged man drinks coffee
Dividend Stocks

Here’s the Average TFSA Balance at Age 35 in Canada

At age 35, it might not seem like you need to be thinking about your future cash flow. But ideally,…

Read more »

ETF stands for Exchange Traded Fund
Dividend Stocks

How to Invest Your $7,000 TFSA Contribution in 2024

Here's how I would prioritize a $7,000 TFSA contribution for growth and income.

Read more »

a man relaxes with his feet on a pile of books
Dividend Stocks

CPP Pensioners: Watch for These Important Updates

The CPP is an excellent tool for retirees, but be sure to stay on top of important updates like these.

Read more »

Technology
Dividend Stocks

TFSA Investors: 3 Dividend Stocks I’d Buy and Hold Forever

These TSX dividend stocks are likely to help TFSA investors earn steady and growing passive income for decades.

Read more »

four people hold happy emoji masks
Dividend Stocks

Love Dividend Growth? Check Out These 2 Income-Boosting Stocks

National Bank of Canada (TSX:NA) and another Canadian dividend-growth stock are looking like a bargain going into December 2024.

Read more »

An investor uses a tablet
Dividend Stocks

A Dividend Giant I’d Buy Over Enbridge Stock Right Now

Enbridge stock may seem like the best of the best in terms of dividends, but honestly this one is far…

Read more »