The Canadian energy sector has been on a roll for the last couple of years. Although there has been a fundamental improvement in the sector’s overall financial position and earnings visibility, these stocks still experience large price swings. Energy remains one of the more volatile sectors in the broader markets.
Canadian energy sector and midstream stocks
If you want to bet on less volatile names, the Canadian midstream space is one apt choice. Among the oil and gas pipeline stocks, Pembina Pipeline (TSX:PPL) has notably outperformed its peers in the long term. To be precise, it has returned 8.4% compounded annually in the last decade, including dividends. In comparison, peers have returned 6.5% in the same period.
Canada is among the top five oil producers globally, producing over 5 million barrels of oil per day. A large part of this production is exported via pipelines because of the relatively lower domestic demand and lack of refineries. As a result, midstream infrastructure like energy pipelines and storage tanks form a vital part of the value chain.
Pembina operates diversified and integrated midstream assets. This includes 5.4 billion cubic feet per day of gas processing capacity and 2.8 million barrels of hydrocarbon transport capacity. Crude oil and condensate form 40% of its revenues, while natural gas contributes 25%. The rest is derived from natural gas liquids.
Pembina has a stable earnings base as volatile oil and gas prices do not significantly impact its financials. It acts as a toll business, and a large chunk of its income comes from long-term, fixed-fee contracts.
Pembina generated almost 82% of its operating profit from fee-based contracts last year. This facilitated high earnings visibility and stability. Interestingly, many contracts on conventional pipelines get revised upwards based on inflation. So, Pembina will likely be able to pass on the higher cost burden to its customers.
A stable earnings base enables regularly growing dividends
Thanks to its low-risk, stable business model, Pembina has grown its operating earnings by 12% compounded annually in the last decade. That’s higher than the industry average and justifies its outperformance. In comparison, peers have seen their bottom line expand by higher single digits.
For 2022, Pembina reported operating profits of $2.8 billion, marking an increase of 9% year over year.
Pembina pays stable dividends and currently yields 6%, way higher than TSX stocks. Such stable earnings growth have fuelled consistent shareholder payout growth. The company has increased its dividends by 5%, compounded annually in the last decade.
Interestingly, there has been an uptick in production in Pembina’s core area, the Western Canadian Sedimentary Basin, because of the favourable economics. As the drilling activity surges, volume and asset utilization should increase, ultimately enabling growth opportunities.
Investor takeaway
Pembina will likely keep growing consistently based on its unique midstream infrastructure and long-term contracts. Thus, investors can expect payouts to grow regularly, at least for the foreseeable future.
Investors may not show the same enthusiasm towards Pembina-like stocks as they do for oil producers when oil prices rise. Yet, the downside for pipeline stocks will also likely be protected when oil prices tumble. So, Pembina is an apt bet for conservative investors seeking a relatively stable, income-generating option from the Canadian energy space.
