Is Inter Pipeline Ltd. (TSE:IPL) A Smart Choice For Dividend Investors?

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Could Inter Pipeline Ltd. (TSE:IPL) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.

With Inter Pipeline yielding 8.4% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can reduce the risk of holding Inter Pipeline for its dividend, and we’ll focus on the most important aspects below.

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TSX:IPL Historical Dividend Yield, June 19th 2019
TSX:IPL Historical Dividend Yield, June 19th 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Inter Pipeline paid out 122% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Last year, Inter Pipeline paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable. It’s disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Inter Pipeline fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we’d view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

Is Inter Pipeline’s Balance Sheet Risky?

As Inter Pipeline’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick way to check a company’s financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures a company’s total debt load relative to its earnings (lower = less debt), while net interest cover measures the company’s ability to pay the interest on its debt (higher = greater ability to pay interest costs). Inter Pipeline has net debt of more than 3x its EBITDA, which is getting towards the limit of most investors’ comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. Inter Pipeline has EBIT of 5.81 times its interest expense, which we think is adequate.

We update our data on Inter Pipeline every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well – nasty. Inter Pipeline has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was CA$0.84 in 2009, compared to CA$1.71 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.4% a year over that time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see Inter Pipeline has grown its earnings per share at 13% per annum over the past five years. With a payout ratio of 122%, Inter Pipeline is paying out dividends substantially greater than what it earned in profit.

We’d also point out that Inter Pipeline issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus – perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. It’s a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Next, growing earnings per share and steady dividend payments is a great combination. Ultimately, Inter Pipeline comes up short on our dividend analysis. It’s not that we think it is a bad company – just that there are likely more appealing dividend prospects out there on this analysis.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 10 analysts we track are forecasting for Inter Pipeline for free with public analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.