CA - Better High Yield Buy: Enbridge Stock Or Hess Midstream Stock

2023-08-31 08:00:00 ET

Summary

• ENB and HESM offer attractive dividend yields.
• Both have very stable cash flow profiles with low commodity risk.
• We compare them side by side and share our view on which is the better buy.

Enbridge ( ENB ) and Hess Midstream ( HESM ) are two high yielding midstream businesses. In this article, we will compare them side-by-side and share our view on which is the better buy at the moment.

ENB Stock Vs. HESM Stock: Business Model

HESM's business model is centered around strategically positioned energy midstream infrastructure that serves both Hess ( HES ) and external parties, offering midstream services for oil, gas, and water. Its business model is high quality with an integrated portfolio that has meaningful scale. This results in a very stable financial performance through energy and macroeconomic cycles along with steady long-term growth. HESM's infrastructure assets provide steady EBITDA growth without requiring significant capital expenditures due to substantial past investments.

Moving forward, HESM has considerable cash flow visibility thanks to it recently securing long-term commercial contracts that extend until 2033, primarily involving fee-based arrangements that reduce exposure to commodity price fluctuations. The company has established Minimum Volume Commitments (MVCs) that offer additional downside protection for over 85% of its revenue and last until 2025. They are generally renewed on a three-year rolling basis. Moreover, an attractive combination of fixed fee and cost-of-service revenue contributes to stable cash flow stability and clear growth prospects.

The strength and stability of the 100% fee-based business model with no direct commodity price exposure is evidenced by the fact that HESM's adjusted EBITDA has grown every year since formation and at a 20% CAGR overall since 2015. This was during a period that saw two great oil price crashes as well as a global economic lock down and recession.

ENB, meanwhile, has a large and well-diversified business that is majority liquids pipelines while also generating a large amount of its EBITDA from gas transmission and distribution. It also has a small, but growing, renewable power generation portfolio as it continues to position itself to continue growing through the ongoing energy transition.

Its cash flows are utility-like, with 51% of its EBITDA coming from take-or-pay contracts and 47% coming from regulated assets. As a result, less than 2% of its EBITDA comes from assets subject to commodity risk. Moreover, over 95% of its customers are investment grade rated and 80% of its EBITDA has inflation protections.

This incredibly robust business model has enabled it to deliver 28 consecutive years of dividend increases to shareholders while also generating substantial total return outperformance:

While both business models are quite impressive, we give the edge to ENB given its superior scale and diversification. This is especially true given that HESM is still largely beholden to its primary counterparty HES and the sponsor ownership of a large chunk of the stock (though this situation has been improving considerably recently as the sponsors have been selling shares and the company has been increasing the publicly owned float to its current level of 24%).

ENB Stock Vs. HESM Stock: Balance Sheet

Both ENB and HESM have strong balance sheets. While ENB has more leverage than HESM does, it still earns a better credit rating (BBB+) given the substantial amount of regulated assets in its portfolio, the high credit quality of its counterparties, and the sheer scale and diversification of its assets.

Along with plenty of liquidity (~$3 billion), ENB is operating within its long-term leverage target. As management stated on its latest earnings call:

our high-quality cash flow profile has little to no commodity exposure and volume risk, while having a high degree of assets earning regulated returns with cost pass-throughs. This underpins our low-risk business model, which is very similar to a utility, allowing us to carry somewhat higher leverage than our pure midstream peers . 95% of our customer base is investment grade and 80% of our EBITDA comes from assets with built-in inflation protection against rising costs. This cash flow predictability supports our strong access to capital and allows us to maintain our strong investment-grade credit rating.

HESM, meanwhile, has a very low 3.0x leverage ratio that is expected to continue declining to below 2.5x by the end of 2025 and has over $1 billion of financial flexibility expected through 2025 thanks to a growing cash balance and leverage capacity. That said, it does lack an investment grade credit rating from S&P with its BB+ credit rating, making its credit rating a full notch below ENB's.

ENB Stock Vs. HESM Stock: Dividend Outlook

As was already stated, ENB has a very impressive 28 year dividend growth streak while HESM has a much shorter 3 year (4 including 2023) dividend growth streak.

That said, moving forward, analysts see HESM growing its dividend per share at a 6.5% CAGR through 2027 with management stating that they expect to grow them at a growth rate of "at least 5%" moving forward.

Meanwhile, ENB is targeting a dividend per share growth rate of "up to medium-term cash flow growth" which is expected to be ~5%. Analysts are less bullish, forecasting a meager 3.1% CAGR for dividends per share through 2027.

ENB Stock Vs. HESM Stock: Valuation

As the table below illustrates, HESM is a bit cheaper than ENB on both a DCF and dividend yield basis:

ENB Stock Vs. HESM Stock: Investor Takeaway

Both businesses offer investors very stable cash flow profiles and sound balance sheets along with well-covered and attractive dividends that are likely to grow for years to come. Both also issue 1099s rather than the more complicated K-1 tax forms that many of their peers hand out, making them more suitable for tax-sheltered accounts and international investors than many other midstream businesses.

In terms of differences, ENB has a much more impressive track record in terms of dividend growth and long-term total returns. Additionally, its cash flow profile is even more secure than HESM's given ENB's greater scale, diversification, stronger counterparty credit ratings, and ENB's significant regulated exposure. ENB also has a BBB+ credit rating and - while its valuation does trade at a premium to HESM's - it is not preventatively more expensive.

That said, since HESM went public in its current format, it has meaningfully outperformed ENB:

Moreover, it is cheaper, has a stronger expected growth profile, has a lower leverage ratio, and its 100% contracted cash flow profile still gives it significant cash flow stability. Last, but not least, ENB is a Canadian company whereas HESM is domiciled in the U.S., so keep the currency fluctuations and potentially different regulatory environments in mind.

We think both stocks are attractive buys at present, but if we had to pick one, we would favor HESM given its higher total return potential while still offering investors a business model that is not high risk. Retirees that want to minimize risks and who place a premium on track record may prefer ENB, however.

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