ENB:CC - Better High Yield Buy: Energy Transfer Or Enbridge?

2023-11-17 09:20:00 ET

Summary

• Enbridge Inc. and Energy Transfer LP are leading midstream businesses.
• Both companies generate stable cash flows, have investment-grade balance sheets, and very attractive and sustainable dividends.
• We compare them side by side and offer our take on which is the better buy right now.

Enbridge Inc. ( ENB ) and Energy Transfer ( ET ) are two leading midstream infrastructure businesses that have strong investment-grade balance sheets, stable cash flow profiles, high yields, and solid long-term growth profiles. In this article, we will compare them side-by-side and offer our take on which is the better buy right now.

ENB Stock Vs. ET Stock: Business Model

ENB has a very strong business model, which is evidenced by its large and diversified asset base and low-risk contractual/regulated cash flows from mostly investment-grade counterparties.

The company's Mainline system is one of its most critical assets through which it controls a significant share of Canada's oil export capacity and provides a vital connection to U.S. refineries. ENB's recent strategic acquisition of natural gas utilities from Dominion Energy ( D ) has considerably expanded its natural gas footprint, making it the largest natural gas utility operator in North America. This move has better balanced ENB's exposure to oil and gas, thereby providing a hedge against commodity price volatility. Its business mix post-acquisition is now 50% in liquids pipelines, 25% in gas transmission, 22% in gas distribution, and 3% in renewables.

ENB's business model is further strengthened by the inflation protections built into its contracts (80% of its EBITDA is inflation-protected) and the fact that 95% of its counterparties are investment-grade. Moreover, its cash flow stability is reinforced by the fact that 98% of its EBITDA comes from long-term take-or-pay contracts and regulated utility assets, minimizing its exposure to commodity price fluctuations. Moreover, ENB is pursuing a significant slate of growth investments, evidenced by its range of projects across its business segments.

ET owns a comprehensive network of energy infrastructure assets, primarily focused on midstream services across the United States. This vast network affords it a competitive edge in terms of scale and access to numerous key markets. It also generates ~90% of its EBITDA from contracted assets and only 10% of its EBITDA is commodity price sensitive. Moreover, the partnership has proven to take a strategic approach to growth over time, leveraging acquisitions to enhance its asset portfolio and organic projects to expand its services. The recent acquisitions of Lotus and Crestwood Equity Partners ( CEQP ) are clear examples of ET's intent to consolidate its market position and diversify its offerings, particularly in key oil-weighted basins that offer growth opportunities.

The company's investment in organic projects and mergers and acquisitions, forecasted at around $2 billion per year, underscores its aggressive growth strategy aimed at expanding its midstream operations and enhancing its natural gas liquids and refined products services. However, the challenge for ET will be to realize returns that exceed the cost of capital, given the historically poor returns on capital in the industry, and ET's weak returns on capital in particular.

Meanwhile, ET's foray into the LNG market, particularly its Lake Charles project, has encountered regulatory hurdles and delays. Nonetheless, ET's pursuit of nonbinding agreements for LNG offtake and the search for equity partners reflect its commitment to this project and its broader strategy to diversify energy offerings. Moreover, recent news on the Lake Charles project is quite positive and indicates that there is a growing probability that it will eventually get put into service and turn out to be a nice cash generator for ET.

ENB Stock Vs. ET Stock: Balance Sheet

ENB's disciplined capital allocation is evident from its BBB+ credit rating, one of the best in the industry. Moreover, its Debt to EBITDA ratio sits at the lower end of its target range of 4.5x to 5x, giving it plenty of financial flexibility moving forward.

Furthermore, ENB's financing plan for its recently announced US Gas Utilities acquisitions is substantially complete, considerably de-risking the financing aspect of its expansion strategy. Beyond this larger acquisition, ENB has primarily been engaging in selective tuck-in asset M&A, which complements its conservative financial posture. When combining its modest Distributable Cash Flow payout range of 60-70% along with one of the lowest risk cash flow profiles among its midstream peers and a very well-laddered debt maturity schedule, ENB's balance sheet is very unlikely to experience distress anytime soon.

ET, meanwhile, despite its past history of running up fairly high leverage ratios that have endangered its investment grade credit rating, has recently taken a much more conservative approach to managing its leverage. Specifically, this has involved paying down billions of dollars' worth of debt, bringing its leverage ratio to the lower end of its 4.0x to 4.5x target range. It even has signaled aspirations to reduce it below 4.0x as part of a deliberate effort to de-risk the partnership's financial profile and enhance the sustainability of its distributions over the long term. With a BBB credit rating at the moment, we could certainly see ET earn an upgrade to BBB+ in the future if it maintains its current course.

ENB Stock Vs. ET Stock: Dividends

ENB's dividend track record is marked by consistency and stability, with 28 years of consecutive annual increases making it arguably the best dividend grower in the entire midstream sector. This is a testament to the strength of ENB's business model and balance sheet that enables it to generate a diversified low-risk stream of utility-like cash flows. Moreover, with a discounted cash flow, or DCF, coverage ratio of ~1.5x of its dividend, the dividend has a significant built-in margin of safety.

Looking forward, the company forecasts a compound annual growth rate of 3-5% in DCF per share, and its dividend is expected to grow at a similar pace. This growth rate, while not aggressive, aligns with ENB's focus on providing a stable and growing return to shareholders that should end up being roughly in line with or slightly above inflation.

ET's distribution track record is not as impressive as ENB's, as it halved its distribution back in late 2020 in order to accelerate deleveraging and preserve its investment-grade credit rating. However, since then ET has grown its distribution rapidly as it has made quick progress towards achieving its deleveraging goals and now pays out a distribution that is superior to its pre-cut level. Moreover, moving forward, management expects to grow the distribution at a compounded annual growth rate of 3-5%, with the additional prospect of unit buybacks in the years to come as its leverage ratio begins to creep below the low end of its target range.

Given ET's recently strengthened balance sheet, stable cash flow profile and ~1.9x DCF coverage ratio of its distribution, ET's payout looks very secure.

ENB Stock Vs. ET Stock: Valuation

ENB's higher EV/EBITDA suggests it is more expensively valued compared to ET. That being said, ENB's current EV/EBITDA ratio stands at 11.24x, against its 5-year average of 12.44x, indicating it is undervalued relative to its historical average. Moreover, ET's current EV/EBITDA of 7.26x is also below its 5-year average of 8.15x, implying that it is also undervalued relative to its historical average. In terms of yield, ET offers a higher current dividend yield at 9.58% compared to ENB's 7.97%, further implying that it is cheaper than ENB.

Looking at the dividend growth prospects, ET is expected to have a higher Dividend CAGR through 2027 at 4.3%, compared to ENB's 3.1%, indicating stronger expected dividend growth for ET. Additionally, ET's P/DCF ratio is lower at 5.45x compared to ENB's 8.32x, which, coupled with its higher DCF CAGR through 2027 at 3.4% versus ENB's 2.3%, suggests that ET may offer a better growth profile as well as a higher current DCF yield.

ENB Stock Vs. ET Stock: Investor Takeaway

ET and ENB are two strong businesses in the energy infrastructure space, each with an attractive value proposition, strong balance sheets, and solid growth trajectories. ENB's stable business model, characterized by its diversified and low-risk asset base, ensures steady cash flows. ET, with its significant geographic presence across the U.S., has a competitive scale advantage and is also increasing its foothold through strategic acquisitions like Lotus and Crestwood Equity Partners.

In terms of dividends, ENB's history of consistent growth and a secure payout ratio indicates a reliable income stream for investors. ET, although having a less consistent distribution history, shows promise with its recently improved balance sheet and a coverage ratio that ensures the current distribution is very sustainable.

Valuation-wise, however, ET really sets itself apart from ENB as the more affordable investment, with lower EV/EBITDA and P/DCF ratios compared to ENB, and a higher expected payout CAGR, making it potentially more attractive to those seeking growth and income at a reasonable valuation. ENB, while trading at higher multiples, offers its own strengths in stability and a track record of growth, appealing to investors who prioritize safety and track record over total return potential. Each stock, therefore, caters to different investor profiles within the energy sector, offering distinct avenues for investment returns. As for us, we rate both stocks as Buys, but think that ET offers the better overall risk-reward profile.

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