Summary
- Enbridge is an oil pipeline company with a 6.5% yield.
- Unlike E&Ps, its profits aren't directly tied to the price of oil; therefore, its dividend is more reliable than theirs are.
- Enbridge's dividend has gradually risen over time.
- The company locks in stable revenue through long-term leases.
- These are all desirable qualities although I can only rate Enbridge 'hold' as it has some balance sheet issues.
Enbridge Inc ( ENB )( ENB:CA ) is a staple of many high yield global stock portfolios. A Canadian pipeline company with a 6.5% yield , it throws off a lot of income. For the most part, the juicy yield has been all investors have gotten with the stock: its price hasn't risen much in five years. However, it has delivered a good total return over 22 years.
Why hasn't ENB stock moved much in the past half-decade?
Part of it might have to do with the sheer percentage of its profit it pays out as dividends. The company's earnings-based payout ratio is 112%. That doesn't leave Enbridge with much retained earnings (technically any), so it shouldn't be surprising that ENB stock hasn't risen much recently despite strong five-year earnings growth . On the other hand, Enbridge measures its own dividend-paying ability via a metric called 'distributable cash flow' (basically cash from operations with a few adjustments), and the modified payout ratio tends to be closer to 70% . It does not look like Enbridge's dividend is in jeopardy, though the lack of retained earnings may play a role in the stagnant stock price.
For income investors, Enbridge stock has a lot of things going for it. Not only is the yield high, but the dividend has grown over time, leading to a rising yield-on-cost. If the company can keep this up, then somebody investing today may enjoy a higher yield tomorrow.
One plausible reason to think that Enbridge could keep up its dividend growth is the fact that it enjoys a strong competitive position. There's only a handful of North American pipelines similar to Enbridge in size , and even fewer that operate in both the U.S. and Canada. Additionally, one of Enbridge's competitors, TC Energy ( TRP )( TRP:CA ) had its Keystone XL project shut down, leaving more room for Enbridge. As a result, Enbridge's competitive position is stronger than it looked like it was going to be a few years ago.
However, it's not Enbridge's competitive position that makes the case for its dividend remaining intact. Rather, it's the fact that the company has long term , locked in contracts. Enbridge customers (in the pipeline business) basically "rent" the right to use the pipeline, once they sign a contract they're in for several years. Past that point, Enbridge just collects the revenue and maintains the pipeline. Thanks to this business model, Enbridge doesn't need high oil prices to make money. At extremely low oil prices its customers might go out of business, but apart from that, the general state of the oil market doesn't impact ENB all that much. For this reason, Enbridge makes a good high yield oil play for those who don't like oil price volatility.
Enbridge - Less Volatile Than E&Ps
Before getting into the opportunity present in Enbridge shares, we need to look at the risks. I basically think that ENB is a good indirect oil play for people who don't like the volatility of regular E&P oil stocks, but it has some risks of its own.
We can start by looking at risk as it is defined in finance textbooks: volatility. For a value investor like me, this definition of 'risk' is not real risk, but it does tell you something about how smooth or bumpy a stock's ride is; so, it may be useful in determining how stressful an experience you'll have owning a stock.
When it comes to volatility, ENB scores pretty well. Its five year beta coefficient is a mere 0.99 , which indicates that it is less volatile than the benchmark (in this case either the S&P 500 or the TSX Composite Index). This suggests that ENB has given investors a fairly smooth ride in the past. It does not mean that the ride will be smooth in the future, but note what I wrote earlier about Enbridge's 8-20 year contracts. The company's revenue over time is just as "smooth" as the stock chart is, so there are fundamental reasons to believe the stock price will continue to chug along relatively peacefully.
As for fundamentals, there are more concerns here.
Enbridge's balance sheet isn't exactly what I'd call stellar. Some selected metrics from it include:
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$131.6 billion in assets.
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$82.7 billion in liabilities.
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$48.8 billion in equity ($42 billion in common equity).
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$59.5 billion in debt.
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$831 million in cash.
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$7.8 billion in current assets.
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$12.9 billion in current liabilities.
Based on these balance sheet metrics, we get:
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1.22 debt/equity ratio (less than 1 is ideal).
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A 0.6 current ratio (more than 1 is ideal).
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A 0.47 quick ratio (more than 1 is ideal).
Basically, you want a debt/equity ratio below 1 because less debt is better than more, and quick/current ratios above 1 because more liquidity is better than less. So, Enbridge is outside of the target zone when it comes to the most popular liquidity and solvency ratios.
ENB's large debt load creates another issue:
Interest expense.
In its most recent quarter, ENB had $837 million in interest expense, up 25% from the same quarter a year before. That's a big increase. The higher interest goes, the lower the earnings, all other things the same. Additionally, ENB's interest expense was a whopping 65% of net income in the quarter! When you have a big cost like interest expense that eats into earnings, it doesn't take much of a revenue decline to produce a large earnings decline. Let's say a company has $5 in fixed costs, $0 in variable costs, and $10 in sales. If sales decline by $1, that's a 1% decline in revenue. However, it's a 20% decline in profit. So, high interest expenses are a potential concern for Enbridge.
I don't mean to draw excessive attention to interest expense here. High amounts of debt are quite common for defensive high dividend sectors like utilities, pipelines and REITs. But in an environment where rates are rising, the interest expense on the debt tends to rise, and that puts earnings at risk.
The good news here is that Enbridge's cash flows are far higher than its GAAP earnings. In the third quarter, net income was $1.3 billion, while distributable cash flow was $2.5 billion. So, if you look at ENB's results from a cash flow perspective, then the interest expense starts to look like less of an issue.
Valuation
Having looked at Enbridge's competitive position and financial health, we can turn to its valuation. Enbridge is certainly not the most expensive stock on earth, trading at:
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18.4 times earnings.
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2.17 times sales.
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1.96 times book value.
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11.96 times operating cash flow .
Pretty low multiples here. At least by the standards of stocks these days. Using the Graham number, a valuation formula developed by 'deep value' investor Ben Graham, we get a 30.85 price target for ENB shares. That is 25% below today's stock price. This valuation method does not look flattering for Enbridge, but remember that deep value investing is just one approach among many. If you have a coherent reason for thinking that a company's earnings will grow over time, then you can justify a higher multiple. As I showed in the section on Enbridge's competitive position, the company does not have many competitors, so it should enjoy a steady stream of business. Additionally, it can achieve growth by improving its infrastructure. For example, the Line 3 replacement will see the current 34 inch pipe replaced by 36 inch pipe. This will increase the amount of oil that can go in the pipe at a given time, which in turn will increase revenue. So, yes, there are good reasons to expect Enbridge to grow over time.
Risks & Challenges
Despite all of the positive things I've said about ENB in this article, there are some risks to watch out for. Among the most pressing include:
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Regulatory/political risk. Pipelines can be politically controversial, and Enbridge has found itself in the crosshairs several times. The most high profile incident the company was involved in was a showdown with the Governor of Michigan . The Governor ordered Enbridge to stop all operations in her State, particularly all activities involving the Line 5 pipeline. The move led to worry among investors and Canadian politicians. Ultimately Enbridge just ignored the order and went about business as usual, but were something like this to happen with a Federal authority, it might go a little differently.
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Rising interest rates. Enbridge has a lot of debt and 10% of it is floating rate . This means that the interest on it goes up when rates rise. As we saw in ENB's third quarter release, interest expenses rise a lot when you have floating rate debt in a period of tightening. The more rates go up, the more ENB's expenses will go up. So far, this threat hasn't become existential, but the more rates rise, the more of an issue it will become.
The issues above are serious enough to merit some thought. On the whole, though, Enbridge is a pretty reliable dividend investment. Its cash flow payout ratio is not as high as it seems, and its earnings have been growing over time. You might not see much in the way of capital gains with ENB, but it should produce reliable cash flows.
For further details see:
Enbridge: 6.5% Yield Even If Oil Crashes