ENBBF - Better High-Yield Midstream Buy: Enbridge Or Plains?

Summary

• Plains All American Pipeline, L.P. and Enbridge Inc. are two high-yield investment grade midstream businesses.
• Plains is far cheaper, but Enbridge has a vastly superior track record.
• We compare them side by side and offer our take on which is a better buy right now.

Both Plains All American Pipeline, L.P. ( PAGP , PAA ) and Enbridge Inc. ( ENB ) are high-yield investment grade midstream businesses. PAA/PAGP is far cheaper, but ENB has a vastly superior track record:

In this article, we will compare them side by side and offer our take on which one is a better buy right now.

Plains Vs. Enbridge: Business Model

ENB's portfolio of assets is considerably larger and is also better diversified than PAA/PAGP's is, which gives it several advantages:

• economies of scale
• insulation from individual asset, commodity, or geographic risk
• some of the best mission-critical midstream service capacity in North America
• numerous organic growth opportunities.

To illustrate these points, Enbridge Inc. owns the second-longest natural gas transmission pipeline network in the United States as well as the largest natural gas distribution business and the longest crude oil pipeline network in North America. It is also growing its renewable power generation business at a brisk pace as it seeks to set its business up for long-term growth through the energy transition.

On top of its geographic and asset diversification and scale, Enbridge Inc. also boasts a very stable cash flow profile, with 98% of its cash flow being commodity price-proof and 95% of its cash flow stemming from investment grade counterparties.

PAA/PAGP, meanwhile, is heavily concentrated on oil midstream infrastructure as its core business operates in the Permian Basin. In fact, its Permian crude and refined products assets bring in approximately 80% of its adjusted EBITDA. It complements this with some NGL assets in Western Canada that provide some diversification to the income stream. While not as impressive as ENB's cash flow profile, PAA/PAGP does still enjoy a fairly stable cash flow profile, with the majority of its cash flows coming from commodity price-resistant contracts as well.

Plains Vs. Enbridge: Balance Sheet

ENB benefits from a sector-leading BBB+ credit rating. This rating is well-deserved, given that its very strong asset portfolio and contract structure is complemented by plenty of liquidity and a debt maturity profile that is mostly concentrated many decades out in the future (the 2030s, 2040s, 2050s, 2060s, and even 2080s).

PAA/PAGP has an investment grade credit rating as well, albeit two notches lower than ENB's at BBB-. However, it still has a lot of liquidity ($3.3 billion, including $600 million in cash on hand), and management has been laser-focused on paying down debt aggressively by using proceeds from non-core asset sales and retained cash flow towards that end. Moving forward, this remains central to its capital allocation strategy, though it plans to be using more of its retained cash flow to grow the distribution as well given that the investment grade credit rating has now been solidified through its recent debt reduction actions. In the coming years, PAA/PAGP plans to earn a credit rating upgrade to BBB by paying off debt as it matures.

Both businesses are in excellent financial shape and are at little risk of financial distress for the foreseeable future.

Plains Vs. Enbridge: Dividend Outlook

PAA/PAGP's management announced in its Q3 report that it expects to grow its distribution/dividend significantly in the coming years:

Management currently intends to recommend to the Board of Directors of PAA GP Holdings LLC (“the Plains Board”) an annualized increase of $0.20 to PAA’s and PAGP’s fourth-quarter 2022 distribution payable in February 2023 (one quarter earlier than our standard beginning-of-the-year annual budgeting process), which would increase the annualized rate from $0.87 to $1.07 per common unit and Class A share. Beyond 2023, as part of its standard annual review process, management anticipates targeting annualized common distribution increases of approximately $0.15 per unit each year until reaching a targeted Common Unit Distribution Coverage Ratio of approximately 160%

Using these metrics, PAA/PAGP will likely grow its payout at a double-digit CAGR in the coming 3-5 years. When combined with its high single digit current yield, it is probably one of the best all around high yield stocks today on a yield plus growth basis.

ENB does not have nearly the exciting growth profile that PAA/PAGP has for its dividend. That said, it has proven to be a much more reliable dividend grower over time, as PAA/PAGP has undergone several brutal dividend cuts over the years whereas ENB has grown its dividend per share for 27 consecutive years, making it a Dividend Aristocrat. Moving forward, it is expected by the consensus analyst estimate to grow its dividend at a meager 2.7% CAGR through 2026, though we think this is probably understating its growth potential. We think ENB will probably be able to grow its dividend per share in the 3-5% range for the foreseeable future given its numerous organic growth projects, strong balance sheet, stable business model, and very reasonable ~68% payout ratio.

Plains Vs. Enbridge: Catalysts And Risks

PAA/PAGP is a riskier midstream business than ENB simply due to its smaller size and lower credit rating. As such, it does not enjoy the same geographic, counterparty, asset, or commodity diversification and strength as ENB either.

As a result, PAA/PAGP's long-term fortunes will largely depend on the fortunes of the Permian Basin. If Permian demand remains strong and even grows over time, PAA/PAGP will be an outperformer in the midstream sector.

Meanwhile, ENB stands as a more broadly diversified bet on the midstream sector while also providing growing exposure to renewables. Given ENB's track record of growing dividends per share consistently and creating significant value for shareholders across numerous economic and energy cycles, it looks a pretty attractive way to invest in the sector broadly. As a result, PAA/PAGP is a more aggressive bet on a specific slice of the sector, whereas ENB is a more conservative diversified bet on midstream.

Plains Vs. Enbridge: Valuation

Based on the data below, we see that PAA/PAGP are significantly cheaper relative to ENB on both a comparative and historical basis:

It is also worth noting that investors pay a considerable premium for PAGP's 1099 tax form as compared to PAA's K-1 tax form (otherwise they are effectively economic equivalents). As a result, we conclude that PAA is a better buy than PAGP if you do not mind dealing with the K-1 tax form. We still think PAGP is attractively priced for investors who are confined to dealing with the 1099.

Investor Takeaway

This comes down to a choice between high concentration, risk, yield, and total return potential in PAA/PAGP and greater diversification, lower risk, lower yield, lower total return potential, but greater dividend growth and better management quality in ENB.

For investors who are building a larger portfolio in the midstream sector and/or are very bullish on the Permian Basin, we think there is definitely room to include PAA/PAGP in your portfolio.

Meanwhile, for investors looking for a diversified one-stop-shop on the midstream sector, we think ENB fits that bill exceptionally well, especially if you do not mind receiving dividends from a Canadian company (which ENB is, whereas PAA/PAGP is not) and want to receive a 1099 tax form rather than a K-1.

Given the makeup of our midstream portfolio at High Yield Investor, we think that PAA is the best fit of these choices for us and we rate it as an attractive Buy at the moment while also giving ENB a buy, though it is not in our portfolio at the moment.

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