Parkland Corp: 4% dividend yield traded at less than 7 X DCF (OTCMKTS: PKIUF)
In February, I looked at Parkland Corporation (OTCPK:PKIUF), a Canadian-based processor and retailer of petroleum products. The company has sought to diversify into other sectors in an effort to increase its EBITDA externally fuel-related business and earlier this year it closed the acquisition of a frozen food retailer. Surprising diversification, but I’ll give Parkland management the benefit of the doubt. Parkland remained on my shortlist and after seeing strong first quarter results and improving refining margins, the company could do better than expected this year.
Since Parkland is a Canadian company, I highly recommend using the company’s Canadian listing which is much more liquid than any of its secondary listings. The average daily volume on the TSX exceeds 400,000 shares. This article is meant as an update to my previous article and to get a better idea of Parkland’s background, I recommend reading my previous article.
Q1 performance was phenomenal with very strong distributable cash flow
Thanks to rising fuel prices and the addition of new divisions, Parkland’s revenues grew from C$4.2 billion to C$7.6 billion. Sure, operating expenses went up as well as COGS nearly doubled, but other expenses like financial expenses went down.
Parkland’s pre-tax profit of C$81m was twice as high as Q1 2021, but there are a few one-time items that had a massive impact on financial results. The income statement shows a loss of C$194 million on hedges and an “other gain” of C$72 million which relates to the change in fair value of the buyout put options to which Parkland is committed. This is a non-cash charge and as I will explain based on business cash flow it has only a limited impact on Parkland’s ability to generate free cash flow. positive.
Despite these one-time losses, net income was C$68M of which C$55M was attributable to Parkland shareholders, resulting in EPS of C$0.36 based on the current share count of approximately 155M of shares.
That’s certainly not great, as it would indicate that the company is trading at 25 times first quarter annualized earnings. But keep in mind that the pre-tax income would have been about three times what was reported now had it not been for the losses in the hedge book.
The majority of hedging losses have been realized and the statement of cash flows shows that only C$27 million of hedging losses have been added back to cash flow. But more importantly, the C$86 million of non-cash expenses related to the loss on the value of the repurchase put options were added back to operating cash flow.
Cash flow from operations was negative C$48 million on a reported basis, but you can clearly see that there was a massive investment in working capital (mainly inventory buildup). Adjusted for these changes in working capital, operating cash flow was positive at C$388 million. However, this includes a C$17 million tax recovery and excludes C$46 million of interest expense and C$37 million of lease payments. Also, I think it’s fair to also deduct the C$13 million of net income attributable to minority interests.
This means that on an adjusted basis, operating cash flow was C$292 million. Total capex was C$55 million, resulting in a free cash flow result of C$237 million. Keep in mind that growth investments are included in this investment figure and according to the breakdown provided by Parkland, only C$29 million of investments supported investments. This means that the maintenance free cash flow was approximately C$263 million or C$1.70/share. Sustaining investments were obviously quite light in the first quarter, as TTM maintenance investments exceeded C$200 million. That’s why you shouldn’t just extrapolate free cash flow from the first quarter to the full year.
Parkland provides an excellent breakdown of its distributable cash flow calculation over the last twelve months. Over the past 12 months, the company has generated over C$700 million in distributable cash flow, or C$4.73 per share.
Parkland recently changed from monthly distributions to quarterly distributions at C$0.325 per quarter. That’s C$1.30 per share per year for a dividend yield of 3.95% based on a C$33 share price. The payout ratio is only 27% based on TTM’s distributable cash flow, meaning Parkland retains approximately half a billion dollars in cash annually to fund its expansion and diversification strategy.
Prospects for 2022 look achievable
One of the main reasons I wanted to review Parkland is the refining division. The company operates the 55-60,000 barrel per day Burnaby Refinery in British Columbia and this refinery has already posted a nice contribution to adjusted EBITDA in the first quarter of 2022.
Refining margins have only increased since Q1 and both in Europe and the US and while Parkland will likely see an improvement in cracking spread as well, keep in mind that Parkland also has a significant business asphalt and aviation fuel, so it remains to be seen how the average refining margin will evolve in the second quarter. I’m optimistic about a good performance in the current quarter, but I can’t really say how much EBITDA from the refining segment will increase.
The official forecast calls for a full year adjusted EBITDA of C$1.5M (C$1.425-1.575B including the potential 5% variation), which facilitates the calculation of projected free cash flow.
We know that the interest costs are approximately 260 million Canadian dollars per year, and that the cost of leases is estimated at 150 million Canadian dollars per year. Sustaining capital expenditure will be C$250m and assuming a 30% average tax rate and C$475m depreciation (excluding leases) per year, sustaining free cash flow for the full year is expected to be around C$750-800 million for a cash flow per share of around C$5/share. And that means the company will continue to self-fund its future expansion plans to reach C$2 billion in EBITDA by 2025.
Despite paying a dividend yielding nearly 4%, Parkland retains approximately C$500 million annually in distributable cash flow on its balance sheet to fund investments in growth and acquisitions. Parkland has already spent C$400 million on acquisitions in the first quarter and will likely complete a C$168 million acquisition of Vopak’s oil terminals in Canada this quarter.
It seems counter-intuitive to invest in a fuel retailer when there seems to be a push for electric vehicles. However, I like Parkland’s focus on diversification away from being a pure fuel retail business and expect future acquisitions to be in a different realm as well. The perception that Parkland is a fuel retail business is likely why the stock is trading at just over 6x distributable cash flow, but the market appears to be distrustful of plans to business expansion despite having C$500 million a year available for growth investments and M&A investments. Parkland is in an exceptional position because it can “buy” its future. It has the capital to reduce its exposure to fuel markets, so an investment in Parkland is a bet on management doing the right thing with its diversification strategy.
I currently have no position in Parkland, but am trying to write put options out of the money.