Over the past 5 years the need for energy transportation has increased considerably. As the demand for energy transportation has increased and is showing no signs of slowing this has presented excellent investment opportunities. A company that focuses on moving oil and gas and is worth considering is Enbridge Inc. (ENB). While there are many different factors to look at and consider when investing, in the article below I will look at the debt side of the company. I will analyze Enbridge's total debt, total liabilities, debt ratios and WACC. From this analysis we should get an idea if the company is highly leveraged, how much it is paying for its debt, what it's paying in taxes and how much to expect in return for investing in this company over the long term.
Gaining knowledge about a company's debt and liabilities is a key component in understanding the risk of a company. In 2008 and 2009 we were able to see some of the repercussions that highly leveraged companies with large amounts of debt succumbed to. Taking into account the debt side of a company might not reveal the "pop" on the upside that an investor would like, but it will help ensure that the company is able to keep its capital and use it for growth in the future.
Currently, Enbridge is involved in the "Northern Gateway project". In my article "Enbridge: Investing in Oil and Gas Transportation" I looked at some of the financial highlights of the company and some of the effects to the shareholder that the Northern Gateway project would have. If you add that article with the article below you will get a good look at Enbridge's fundamental strengths and weaknesses.
In the article below, I will calculate important ratios in understanding the amount of debt and liabilities the company has incurred. From this analysis we will understand more about the company's debt, liabilities and financial risk. If this summary is compared with other companies in the same sector, such as Transcanada Corporation (TRP), you will be able to see which company has the most debt, thus adding to the company and investor risk.
1. Total Debt = Long-Term Debt + Short-Term Debt
Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt due within one year.
- 2008 - $11.629 billion + $1.593 billion = $13.222 billion
- 2009 - $12.974 billion + $1.222 billion = $14.196 billion
- 2010 - $14.622 billion + $550 million = $15.172 billion
- 2011 - $15.208 billion + $1.024 billion = $16.232 billion
- 2012 - $20.203 billion + $1.714 billion = $21.917 billion
Enbridges total debt has increased over the past five years. In 2008 Enbridge posted a total debt of $13.222 billion while in 2012 the company posted a total debt of $21.917 billion. This signifies an increase of 65.76% over the past 5 years.
2. Total Liabilities
Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities are the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.
- 2008 - $18.083 billion
- 2009 - $20.908 billion
- 2010 - $22.555 billion
- 2011 - $25.502 billion
- 2012 - $36.672 billion
Over the past five years Enbridge's liabilities have also increased. In 2008, Enbridge reported liabilities of $18.083 billion while in 2012 Enbridge reported liabilities at $36.672 billion. This marks an increase of 102.80%.
In analyzing Enbridge's total debt and liabilities, we can see that the company currently has a total debt of $21.917 billion and liabilities at $36.672 billion. From the numbers above, we can see that over the past five years Enbridge's total debt has increased by 65.76%, while the total liabilities have increased by 102.80%. As the company's amount of debt and amount of liabilities have increased, the next step will reveal if the company has the ability to pay them.
1. Total Debt to Total Assets Ratio = Total Debt / Total Assets
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.
A debt ratio of greater than 1 indicates that a company has more total debt than assets. Meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
- 2010 - $15.172 billion / $30.120 billion = .50
- 2011 - $16.232 billion / $34.343 billion = .47
- 2012 - $21.917 billion / $47.172 billion = .46
Enbridge currently has a total debt to total assets ratio of .46. As the total debt to total assets ratio has decreased over the past three years, this indicates a slight decrease in risk to the company. Because the 2012 number is below the 1 and decreasing this indicates a diminishing amount of risk to the shareholder.
4. Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.
- 2010 - $22.555 billion / $30.120 billion = .75
- 2011 - $25.502 billion / $34.343 billion = .74
- 2012 - $36.672 billion / $47.172 billion = .78
In looking at Enbridge's total liabilities to total assets ratio over the past three years, we can see that this ratio has also increased. The ratio has increased from .75 in 2010 to .78 in 2012. As the ratios are above the 0.50 mark, this indicates that Enbridge has financed some of the company's assets through debt. As the number has increased, so has the risk to the company.
5. Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
- 2010 - $22.555 billion / $7.565 billion = 2.98
- 2011 - $25.502 billion / $8.841 billion = 2.88
- 2012 - $36.672 billion / $10.500 billion = 3.49
Compared with 2010, Enbridge's debt-to-equity ratio has increased. The ratio has increased from 2.98 to 3.49. As the ratio is currently well above 1, this indicates that suppliers, lenders, creditors and obligators have more invested than shareholders. 3.49 indicates a high amount of risk for the company. As the ratio is above 1 and considered high, so is the risk for the company.
6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.
- 2010 - $14.622 billion / $22.187 billion = .65
- 2011 - $15.208 billion / $24.049 billion = .63
- 2012 - $20.203 billion / $30.703 billion = .66
Over the past three years, Enbridge's capitalization ratio has increased from .65 to .66. This implies that the company has less equity compared with its long-term debt. As this is the case, the company has had less equity to support its operations and add growth through its equity. As the ratio is increasing, financially this implies a slight increase of risk to the company.
7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
- 2010 - $1.851 billion / $15.172 billion = 0.12
- 2011 - $2.703 billion / $16.232 billion = 0.17
- 2012 - $2.874 billion / $21.917 billion = 0.13
As the current cash flow to total debt ratio is well below 1, this implies that Enbridge does not have the ability to cover its total debt with its yearly cash flow from operations.
Based on the five debt ratios listed above, we can see that Enbridge has a substantial amount of risk regarding the company's debt and liabilities. The above ratios state that there has been a slight increase in the company's debt levels compared to the company's assets over the past 3 years. Currently, the company is not showing signs of going bankrupt but the debt side of the company does carry substantial risk. This comment is supported by the amount of debt the company currently carrying, the high debt to equity ratio, the increase in the capitalization ratio and the low cash flow to total debt ratio. The next step will reveal how much the company will pay for the debt incurred.
Cost of Debt
The cost of debt is the effective rate that a company pays on its total debt.
As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt is a useful metric. It gives an idea as to the overall rate being paid by the company to use debt financing. This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.
8. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- S&P rated Enbridge bonds "A-"
- Enbridge Inc Mtn Cds- 4.53% Rate of "A-" = 4.53%
- Current cost of Debt as of April 20th 2013 = 4.53%
According to the S&P rating guide, the "A-" rating is - "Strong capacity to meet financial commitments but somewhat susceptible to adverse economic conditions and changes in circumstances." Enbridge has a rating that meets this description.
9. Current tax rate = (Income Tax total / Income before Tax)
- 2010 - $251 million / $1.221 billion = 20.56%
- 2011 - $568 million / $1.628 billion = 34.89%
- 2012 - $128 million / $1.071 billion = 11.95%
2010 - 2012 3-year average = 22.47%
From 2010 - 2012 Enbridge has averaged tax rate of 22.47%.
10. Cost of Debt (After Tax) = (Cost of Debt Before Tax) (1 - Tax Rate)
The effective rate that a company pays on its current debt after tax.
- .0453 x (1 - .2247) = Cost of debt after tax
The cost of debt after tax for Enbridge Inc. is 3.51%
Cost of Equity or R Equity = Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
The cost of equity is the return a firm theoretically pays to its equity investors (for example, shareholders) to compensate for the risk they undertake by investing in their company.
- Risk Free Rate = U.S. 10-year bond = 1.70% (Bloomberg)
- Average Market Return 1950 - 2012 = 7%
- Beta = (Google Finance) Enbridge Inc Beta = 0.63
Risk Free Rate + Beta Equity (Average Market Return - Risk Free Rate)
- 1.70 + 0.63 (7- 1.70)
- 1.70 + 0.63 x 5.3
- 1.70 + 3.34 = 5.04%
Currently, Enbridge Inc has a Cost of Equity or R Equity of 5.04%, so investors should expect to get a return of 5.04% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.
(Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2012 at 7%, the U.S. 10-year bond for the risk-free rate, which is susceptible to daily change and Google Finance beta.)
Weighted Average Cost of Capital or WACC
The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.
As the WACC of a firm increases, and the beta and rate of return on equity increases, this is an indicator of a decrease in valuation and a higher risk. By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances. For this calculation, you will need to know the following listed below:
Tax Rate = 22.47%
Cost of Debt (before tax) or R debt = 4.53%
Cost of Equity or R equity = 5.04%
Debt (Total Liabilities) for 2012 or D = $36.672 billion
Stock Price = $45.00 (April 20th, 2013)
Outstanding Shares = 806.46 million
Equity = Stock price x Outstanding Shares or E = $36.290 billion
Debt + Equity or D+E = $72.962 billion
WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - .2247) x .0453 x ($36.672/$72.962) + .0504 ($36.290/$72.962)
.7753 x .0453 x .5026 + .0504 x .4974
.0177 + .0251
Based on the calculations above, we can conclude that Enbridge Inc pays 4.28% on every dollar that it finances, or 4.28 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0428 plus the cost of the investment for the investment to be feasible for the company.
Debt Side Summary
All indications above reveal that Enbridge Inc has increased its risk from a debt point of view over the past three years. This is supported by the increase in many of the ratios in the above analysis. Having stated this the company does have analysis support by S&P which assigned them an "A-" rating which implies the company has a "Strong capacity to meet financial commitments but somewhat susceptible to adverse economic conditions and changes in circumstances.". The CAPM supports the stability of the company by revealing that the investor needs 5.04% year-over-year over the long term to get good value on his or her money.
B. Annual growth rate
- EPS 2010 = $1.30
- EPS 2011 = $1.32
- EPS 2012 = $0.79
- EPS 2013 = $1.83 (Estimate)
- EPS 2014 = $2.14 (Estimate)
(A / P) ^ (1 / T) - 1 = R
(2.14 / 1.30) ^ (1 / 5) - 1 = R
R = 10.48%
Earnings per share average growth rate over the 3 past years and estimated 2 years forward = 10.48%
Current PE Ratio = 59.19 (Google Finance)
59.19 / 10.48 = 2.28
PEG Ratio = 5.65
A current PEG ratio of 5.65 based on an EPS average growth rate from 2010 to 2014 indicates that based on the next few years estimates the stock is currently at overvalued. This overvalue could also be an example of the industry being a place where many other investors want to be as there is currently a need for energy transportation.
Chart sourced by FINVIZ
The above analysis reveals that Enbridge Inc is a solid company but has a large amount of debt on its books. The company has a strong rating by S&P with a rating of "A-" with a "stable outlook". Currently, the peg ratio states that the stock is overvalued but as there is a need for energy transportation in North America this offsets some of the overvalue. Based on the chart above, we can see that the stock is currently on a strong uptrend. Even though there is an enormous need for energy transportation in North America a large factor on the stock price will be if the controversial "Northern Gateway Project" goes through. As the company has a large amount of debt on its books, a closure of the project would be extremely negative for the fundamentals of the company and the stock price moving forward.
Based on the evidence presented above, Enbridge is in a decent financial position. Enbridge has the ability to pay for its debts, has a strong rating by S&P and has a product that is in demand. There are many risks and obstacles moving forward for the company but until there is clear evidence of a negative turn regarding the Northern Gateway Project the long term positive trend should continue.