CA - Enbridge Baby Bonds: Where To Go Next

Summary

• We had suggested Enbridge baby bonds as a way to play the hawkish Federal Reserve.
• The baby bonds have moved near par value.
• We discuss what the odds are for redemption and what are alternative securities to consider.

We have been fans of Enbridge Inc. ( ENB ) and its preferred securities for as long as we can remember. On our more recent coverage, we assigned the buy rating for its baby bonds, Enbridge Inc. 6.375 SNT18 B 78 ( ENBA ). Specifically, we said:

This is a massively-sized issue as well, with $533 million in float. Paying $16-$23 million extra annually is not exactly going to be easy for CFOs to digest. Pembina Pipeline Corporation ( PBA ) balked at the idea of even locking in a five-year fixed rate at 7.25% on its preferred shares, and its credit rating is one notch below that of Enbridge. So, redemption appears to be very probable and would result in a very strong return over the next six months (about 14.6% annualized).

Source: An Easy Way To Play A Hawkish Fed

In this follow-up, we evaluate the performance of the idea and the current odds of redemption. We suggest an alternative for those that want to hold Enbridge for longer.

ENBA

Since the article was written, ENBA has gradually moved to near par and is trading at $24.86. With April 15, 2023 coming up, the odds of the security being called are increasing. There are two reasons for this. The first being that the Federal Reserve has delivered on its hawkish promise and the rate hikes have come to fruition. We should see another one soon that takes the Fed Funds even higher. Beyond that, it is toss-up whether the Fed will stop here and go another quarter point. ENBA will be set to pay close to 8.5% from April.

On 4/15/2023 until 4/15/2028 the interest rate on the Notes will be reset at per annum equal to the three-month LIBOR plus 3.593%

Source: ENBA Prospectus

While the cost of this baby bond will increase as predicted, Enbridge's long-term bonds in US dollars now yield about 5.3%.

On the Canadian side, the yields are similar with bonds due August 27, 2042 yielding 5.36% to maturity (Source: CIBC).

Mathematically, this is getting into the "no-brainer" zone. The idea of letting this float will be revulsive to any of the C-suite folks. While the Fed Fund futures are pricing in some rate cuts, longer-term financing makes too much sense and ENBA redemption is a virtual certainty here.

Staying Involved

There is nothing bad about making a 14.6% annualized return (from our original article) with low risk. But where do income holders go next if they want to be involved with Enbridge? While there is a multitude of choices to get income from Enbridge, including common shares, covered calls, preferred shares and bonds, we show the one we prefer for US Dollars.

Enbridge Inc. Cumulative Redeemable Reset Rate Preference Shares, Series L ( EBBNF ) ( ENB.PFU:CA )

These Enbridge preferred shares were recently reset. We are showing below the relevant portions of the press release.

Enbridge Inc. announced today that it does not intend to exercise its right to redeem its currently outstanding Cumulative Redeemable Preference Shares, Series L (Series L Shares) on September 1, 2022.

The new annual dividend rate applicable to the Series L Shares for the five-year period commencing on September 1, 2022 to, but excluding, September 1, 2027 will be 5.85790 percent, being equal to the five-year United States Government treasury bond yield of 2.70790 percent determined as of today plus 3.15 percent in accordance with the terms of the Series L Shares.

Source: Enbridge

So the dividend rate is fixed for the next five years at 5.85790%. That may not sound like a lot. But considering the discount to par, it is game on.

That works out to a 7.33% yield. Keep in mind that even ENBA is just paying 6.38%. It was the move to the far higher rate that created a hook to buy it. So if you held ENBA, you can consider moving to EBBNF.

There are three reasons we really like EBBNF. The first being that the preferred shares have just been reset, so you have the yield locked in for the next 4.75 years. You are past the worry for what you will get, unlike that for many other preferred shares that have their resets ahead.

The second reason is that the reset happened while the 5-year yield was just at 2.7090%. This creates a low bar in the future. As long as the rate is above that number in September 2027, your reset in the future will be higher.

Finally, EBBNF offers you a very strong extra return to take on the variable dividend down the line. The 7.33% yield from a BBB- security gives you about 1.8% extra per year for the next 4.75 years relative to comparable fixed rate preferred shares. We have shown three fixed rate preferred shares below, but there are a lot more.

• AT&T Inc. 5% DEP RP PFD A ( T.PA ) yields 5.7% and is a fixed rate security rated BB+ by S&P.
• Kimco Realty Corporation 5.25% DEP SHS M ( KIM.PM ) offers a 5.6% yield currently and is rated BBB- by S&P.
• The Allstate Corporation 4.75% DP SH PF I ( ALL.PI ) offers a 5.22% yield currently and is rated BBB- by S&P.

So yes, you do have some reset risk with EBBNF but it pays you well to take it.

Verdict

ENBA will be called barring a very sudden reversal in Federal Reserve tone. Enbridge continues to deliver excellent results quarter after quarter, and it can issue debt at very low rates. We like EBBNF as a way to stay involved with Enbridge in US dollars. EBBNF is best purchased on the TSX, where it trades as ENB.PFU. We also own other Enbridge securities on the Canadian dollar side.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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