Inter pipeline strong income play – inter pipeline ltd (otcmkts ipplf) seeking alpha electricity symbols ks2 worksheet

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As bond yields and the price of crude oil inch higher, inflation will sooner or later become an issue for income based investors. Dividend stocks which have not been growing their dividend at a reasonable clip will come under pressure as there will be more options open to income derived investors. One option is Inter Pipeline Ltd. ( OTCPK:IPPLF) which pays out almost a 7%+ dividend. Obviously, with these kinds of yields, doing the necessary due diligence is critical before attempting to scale into any sort of long position.

When researching the dividend, investors must look at the history of the dividend payout as well as whether the dividend can be covered by present and future cash flows. Looking at the past record is the easy bit. The difficulty is in always trying to predict future growth which invariably is needed if the dividend is to keep on growing. The last thing a dividend investor wants to happen is for the shares, for example of Inter Pipeline, to head south at a rate of knots which then would put the dividend at risk of a cut. Therefore, would we be interested in Inter Pipeline as a dividend paying stock? Let’s dig in…

Inter Pipeline has increased its dividend since 2011. Although dividend growth has been slowing, it still grew its dividend by 0.06 Canadian dollars to hit 1.63 in 2017. This gives the company a 12-month dividend growth rate of around 3.8%. Although for inflation purposes, I would go back to the 3-year or 5-year growth rates (which are 7.3% and 9.4%) which are well above inflation levels, the one year is also important as it’s the most recent. At almost 4% (combined with the sizable 7% yield), we have no problem here so far regarding potential loss of purchasing power.

So is this dividend yield and growth rate sustainable. As a dividend investment, we want to make sure to the best of our ability that the stock will be able to spit out rising dividend payments at will without too much bother to the financials. Here we look at the cash flow payout ratio. Many investors calculate this ratio from earnings, but we prefer to do it from the company’s free cash flow.

Since we are in mid-year, we can calculate this ratio over a trailing 12-month average. We therefore get the average of the dividends paid out over the past 4 quarters and divide this total into the free cash flow average over the same time period. Over this average, the free cash flow payout ratio comes in at around the 54% mark. Again, this number looks attractive enough and shows potential for future dividend increases.

That’s all historical stuff, though. In terms of future sustainability, we like to look at the interest coverage ratio, the debt to equity ratio and forward looking earnings projections. Furthermore, we want to look at how these critical metrics are trending to ensure we are giving the investment maximum potential to succeed.

For example, the interest coverage ratio at present over a 12-month trailing average is 5.41 which means the company’s pre-tax profits dwarf the interest payments on the debt by just over 5 times. Again, nothing untoward here especially given that the metric is above average over the past decade.

From a balance sheet point of view, the company’s debt to equity ratio over a trailing 12-month average currently comes in at 109%. Again, the company doesn’t look overly indebted here and the ratio is both under its 10-year average and at its lowest level since 2012.

The final piece of the jigsaw is expected earnings growth. 7% earnings growth is expected this fiscal year and around 3% next year. Although we are seeing projected strength this year, next year looks a bit flat which is why the earnings trends are slightly trending down. Remember the market is always forward looking so any adverse movement on that 1.56 EPS estimate for next year will affect the share price and of course dividend growth. Net income is the first line item on the cash flow statement. Irrespective of how efficient a company is at generating cash flow, earnings growth invariably needs to be there in order to sustain meaningful dividend growth rates.

To sum up, this stock goes on our watchlist as a possible income candidate, but we would need to see more on the earnings side first. There is a lot of competition in this field at the moment regarding dividend income. As always, protecting the downside is key