BIPAF - 2 High Yield Canadian SWAN Aristocrats: Enbridge And ATCO

2023-03-17 10:30:00 ET

Summary

• ENB and ACLLF are both Canadian infrastructure businesses that offer high and safe dividend yields.
• They combine strong investment-grade balance sheets and stellar assets with impressive dividend growth track records that enable investors to sleep well at night.
• We look at their valuations and growth prospects and explain why we own one of these and not the other.

Enbridge (ENB) and ATCO (ACLLF) are both Canadian infrastructure businesses that offer high and safe dividend yields. They combine strong investment grade balance sheets and stellar assets with impressive dividend growth track records that enable investors to sleep well at night. Furthermore, both have meaningfully outperformed the market over the long-term.

In this article, we look at their valuations and growth prospects and explain why we own one of these and not the other.

ENB Analysis

ENB is a midstream infrastructure business that also features a small but growing renewable power segment. It has grown its dividend for 28 years, giving it a phenomenal track record as a consistent dividend grower and wealth compounder for shareholders.

ENB's exceptionally stable cash flow profile is supported by 98% of its cash flow being linked to commodity price resistant contracts. Furthermore, 95% of its cash flow is backed by investment-grade counterparties.

ENB's portfolio includes some of the most impressive midstream assets in North America, including the continent's largest natural gas distribution business, the second-longest natural gas transmission pipeline network in the U.S., and North America's longest crude oil pipeline network.

This large and diversified asset portfolio provides multiple advantages, including protection against individual asset, commodity, or geographic concentration risk, economies of scale benefits, plentiful high return, low risk growth investment opportunities, and an irreplaceable, mission-critical role in North America's energy value chain.

Moreover, ENB has a strong financial position with a midstream sector-leading BBB+ credit rating, fixed interest rates on the majority of its debt that are termed out many decades into the future, including as far out as the 2080s, a leverage ratio that falls within the lower half of its target range, and steady cash flow supported by diversified assets. This suggests that the company faces little to no financial distress risk in the near future.

While analyst consensus estimates predict that ENB will grow its dividend at a 3.7% CAGR through 2026 and its DCF per share at a 2.6% CAGR over the same period, the company's guidance and its track record suggest that it will likely outperform these predictions. At its recent investor day , the company guided for 5% average annual growth moving forward, which seems quite achievable given the stability of the cash flows from its current assets, its stable debt picture, its buyback program, lucrative growth investments, and growing renewable power business. Furthermore, since 2017, ENB has grown its DCF per share at an 8% CAGR and since 2019 it has grown DCF per share at a 6% CAGR, so a 5% CAGR moving forward is certainly within its proven capability.

While the business is well insulated from short-term volatility in the energy industry, longer-term trends will have a meaningful impact on its long-term growth. If the energy sector continues to grow long-term, ENB will benefit from higher contract fees on its current assets and more opportunities for organic growth. However, in the event of a much more rapid energy transition than is currently expected, ENB may have to contend with reduced contract fees, excess network capacity, and limited opportunities for growth investment. On the other hand, its growing business in renewable power production helps to hedge against this uncertainty, giving it a more stable long-term growth outlook than many midstream businesses.

ACLLF Analysis

ACLLF is a diversified global infrastructure business headquartered in Alberta, Canada, with around 6,400 employees and assets worth ~$24 billion. The company provides essential services to over two million clients worldwide. Over the 20-year period from 2002-2022, ACLLF delivered a 10% total return CAGR, compared to the 8.5% CAGR delivered by the S&P/TSX Composite index.

Like ENB, it has an impressive dividend growth streak that now numbers 30 consecutive years. Its primary business is its controlling stake in Canadian Utilities ( OTCPK:CDUAF ), which provides it with highly defensive earnings from regulated assets that tend to generate returns on equity above peers.

In 2022, the Canadian Utilities business generated 82.3% of its total adjusted earnings, while its Structures & Logistics business generated 14.4% of its total adjusted earnings, and its Neltume Ports investment contributed 3.3% of its total adjusted earnings. It classifies 78% of its portfolio as core infrastructure and 22% of it as high growth and is focused on improving its overall portfolio and geographical diversification with an increasing focus on investing in high growth investments.

Its Structures & Logistics business is a major growth driver for the company, sporting 15% year-over-year growth in adjusted earnings in 2022. Meanwhile, its Neltume Ports business also has attractive growth fundamentals, though it is such a small part of the business that its contributions to overall bottom line growth will likely remain minimal for the foreseeable future.

The Canadian Utilities business boasts a 10-year average ROE of 10.6%, which is well above the 8.5% AUC approved average ROE over that same time span. This reflects well on the quality of the business and its management. As part of its utilities business, ACLLF is also investing aggressively in energy transition infrastructure, including solar and wind power generation, Hydrogen projects, clean fuels, and renewable energy storage.

The balance sheet is in excellent shape as well, with a BBB+ credit rating from S&P.

In 2022, it grew adjusted earnings per share by 10.75%, which is a very impressive result given that it also pays out a substantial dividend. Moving forward, it should be able to sustain a high growth rate thanks to its considerable cash flow retention from its relatively low payout ratio. It is deploying this retained cash into growth investments, including the December 2022 acquisition of Triple M Housing (a leading North American modular home manufacturer) and the January 2023 acquisition of a wind and solar portfolio from Suncor Energy ( SU ). It also continues to win significant contracts for its Structures & Logistics business while investing in CDUAF's aggressive growth pipeline.

Investor Takeaway

While both are undoubtedly excellent businesses that will continue to grow their dividends for many years to come, ACLLF stands out to us as being an exceptionally attractive buy compared to its infrastructure and utilities peers whereas ENB is still a Buy, but not particularly attractively priced relative to peers.

ACLLF currently trades at a discount to the publicly traded value of its underlying CDUAF stake (which is already relatively attractively priced on its own) net of debt, so on that basis alone it is a compelling value investment. Furthermore, investors get the rapidly growing structures business for free along with the Neltume Ports business. Put another way, ACLLF only trades at an 8.22 EV/EBITDA while combining a 4.5% current dividend yield with a double-digit annualized adjusted earnings per share growth rate. Canadian utility peer Fortis ( FTS ) trades at an EV/EBITDA of 12.3x and Canadian infrastructure peer Brookfield Infrastructure ( BIP )( BIPC ) trades at an EV/EBITDA of 18.9x. When you combine the relatively low risk in the balance sheet and business model with the yield plus growth plus potential for multiple expansion, you get one of the most attractive risk-adjusted total return profiles in the market today.

ENB, meanwhile, trades at an 11.9x EV/EBITDA and offers a 7% dividend yield. While a 7% yield plus 3-5% annualized growth makes for a very strong case for relatively low risk double digit annualized total returns for the foreseeable future, we do not anticipate much valuation multiple expansion at all given that many of its peers trade at considerable discounts to ENB on an EV/EBITDA basis. As a result, we still rate ENB a Buy, but do not hold it in our portfolio at High Yield Investor. In contrast, we rate ACLLF a Strong Buy and hold it as one of our larger positions.

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