Pembina Pipeline: Little Growth, Billions Of Dollars Later (PBA)

Introduction

The last time discussing Pembina Pipeline (NYSE:PBA), it seemed that 2022 was looking up, although their dividends were still trapped near their limit, as my previous article warned. Well over one year later and as expected, only minor dividend growth was forthcoming and with 2023 now here, it seems timely to have a look at what sits ahead. Disappointingly, even billions of dollars later, there is little growth on the horizon that in my eyes, caps the upside potential for their share price.

Coverage Summary & Ratings

Since many readers are likely short on time, the table below provides a brief summary and ratings for the primary criteria assessed. If interested, this Google Document provides information regarding my rating system and importantly, links to my library of equivalent analyses that share a comparable approach to enhance cross-investment comparability.

Detailed Analysis

It was positive to see their operating cash flow recover during 2021 back to C$2.65b after having suffered during 2020 as their result plunged to C$2.252b versus its previous result of C$2.532b during 2019. As 2022 progressed, their operating cash flow only climbed slightly ahead with a result of C$2.026b across the first nine months versus their previous result of C$1.953b across the first nine months of 2021, although in the case of the latter, it was skewed by working capital movements.

If zooming into their quarterly results, their working capital movements each quarter across the first nine months of 2022 broadly net out against each other, thereby leaving only an immaterial draw of C$15m. Whereas, the first nine months of 2021 saw its quarterly working capital movements aggregated to a build of C$70m, which weighed down their reported results. If these were both excluded, their underlying result for the first nine months of 2022 would have only been slightly higher at C$2.041b but importantly, their previous underlying result for the first nine months of 2021 climbs to C$2.023b. As a result, this means that beneath the surface, 2022 was not materially stronger than 2021 and when looking ahead into 2023, this appears set to continue once again.

When it comes to the most important aspect of their 2023 guidance, their adjusted EBITDA, it tells a mixed story that in my eyes, is ultimately lackluster. On one end, the top of their guidance range is raised to C$3.8b, which represents a small increase of circa 2% year-on-year versus the top of their guidance range for 2022 of C$3.725b. Whereas on the other end, the bottom of their guidance range for 2023 drops to C$3.5b and thus actually represents a decrease of circa 3.50% year-on-year versus the bottom of their guidance range for 2022 of C$3.625b. I see this widening range in 2023 as opening the door for disappointment, especially with the midpoints falling ever-so-slightly to C$3.65b for 2023 versus C$3.675b for 2022. Holding everything else constant, it seems reasonable to expect their operating cash flow will be broadly flat year-on-year in 2023 versus 2022 given its positive correlation with adjusted EBITDA.

Whilst the midstream industry is not necessarily known for high growth, it nevertheless remains lackluster to see almost no growth even at the top of their guidance range. Even after years of multi-billion dollar investments building out their company, as soon as they wind down their capital expenditure down to a more modest level, their growth essentially stagnates. When looking at the other important component of their guidance for 2023, it sees their capital expenditure guidance remaining restrained, which if nothing else, at least supports their free cash flow generation.

When turning to this element of their guidance for 2023, they are forecasting capital expenditure of C$730m when including their equity-accounted investees. During the first nine months of 2022, their capital expenditure was C$504m, which annualizes to C$672m and thus within the same ballpark as their guidance for 2023. Since their accompanying estimated operating cash flow should also stay in the same ballpark as 2022, so too should their estimated free cash flow. By extension, this means their strong dividend coverage of 129.86% during the first nine of 2022 should broadly continue during 2023, give or take a little depending upon working capital movements.

Whilst positive from a dividend safety standpoint, the lack of materially higher capital expenditure almost certainly means that 2024 will not see materially stronger financial performance. Due to this lack of growth, it effectively caps their scope for dividend growth and therefore, it also caps the upside potential for their share price. Even though their strong dividend coverage provides extra capacity, at circa 130% it does not provide a massive scope without negatively impacting their margin of safety and thus, increasing their risk profile. Plus, without any fundamental growth to their operating cash flow, even at best this would only be a temporary sugar hit if utilized to push their dividends higher.

Admittedly, share buybacks can help provide dividend growth via reducing their outstanding share count, their excess free cash flow after dividend payments was only C$312m during the first nine months of 2022. This annualizes to C$416m, which amounts to less than 2% against their current market capitalization of approximately C$25.5b, therefore barely moving the needle even if they pushed every last dollar into share buybacks and whilst their financial position is solid, it cannot resolve this issue.

After seeing their net debt steadily trending upwards for years, it seems 2022 finally marked a change whereby this reversed, which decreased to C$10.327b following the third quarter versus its previous level of C$11.196b following the end of 2021. Whilst their excess free cash flow after dividend payments helped, it was largely their accompanying C$609m of divestitures that made the biggest difference.

When looking ahead into 2023, their net debt should continue trending downwards thanks to their excess free cash flow after dividend payments, assuming no further material divestitures nor acquisitions. Although, the extent could be very low depending upon how much they allocate to share buybacks and working capital movements. As a side note, their guidance for 2023 states their partly-owned PGI subsidiary is divesting assets for C$662.5m in early 2023. Since PGI is an equity-accounted investment, Pembina Pipeline will not see these proceeds impacting the cash or debt as listed on their balance sheet.

Primarily thanks to their lower net debt, their leverage dropped lower during the first nine months of 2022 with their net debt-to-EBITDA landing at 2.96 versus its previous result of 3.51 following the end of 2021. This was accompanied by their net debt-to-operating cash flow decreasing to 3.85 versus their previous result of 4.22 across these same two points in time. Whilst the former is now within the moderate territory, the latter remains within the high territory of between 3.51 and 5.00.

Whilst their lack of forecast earnings nor cash flow growth for 2023 will not help reduce their leverage itself, at least their outlook for lower net debt should make for a small decrease. That said, their existing leverage is not problematic for a midstream company, especially given their accompanying debt serviceability and liquidity. Although at the same time, this obviously does not resolve their lack of scope for dividend growth.

Even though central banks have been rapidly tightening monetary policy during 2022, their lower net debt still helped their debt serviceability. Following the third quarter of 2022, if comparing their interest expense against their EBIT it now sees coverage of 7.29, whereas in the past, this was only 6.82 following the end of 2021. Meanwhile, their interest coverage when utilizing their operating cash flow sees results of 7.06 and 7.32 respectively, which are effectively flat given the usual minor volatility in cash-based results. Either way, this now sees perfect debt serviceability in both instances, which should be continued during 2023 given their aforementioned guidance and resulting outlook for their net debt.

Apart from helping suppress their leverage, their excess free cash flow after dividend payments also helped improve their liquidity. Whilst their current ratio of 0.65 following the third quarter of 2022 is still somewhat low, it nevertheless represents an improvement versus their previous result of 0.52 following the end of 2021. More so, their accompanying cash ratio increased to 0.12 versus its previous result of only 0.02 across these same two points in time, thereby ensuring their liquidity is adequate. When combined with their large operational size and continued free cash flow outlook, it removes any dependence upon their credit facility or risk from debt maturities within the foreseeable future.

Conclusion

Even though the outlook for their earnings growth and by extension, cash flow growth is lackluster, if nothing else, their financial position remains solid for a midstream company and thus, their dividends are safe. That said, their lack of growth caps their scope for dividend growth as well as the upside potential for their share price. In light of this outlook, it is not surprising to see their share price is still broadly around its same price as the middle of 2021 and thus once again, I only believe that a hold rating is appropriate.

Notes: Unless specified otherwise, all figures in this article were taken from Pembina Pipeline’s SEC filings, all calculated figures were performed by the author.