The Falling Knife Worth Catching This Week
Summary
- Management announced double-digit dividend growth for many years.
- It started the year with a +10% increase, yet the stock is down 20% year to date.
- Are investors expected to be “Kindered” again?
The stock market is full of irony. When management announces double-digit dividend growth for several years, you usually expect investors to open champagne and celebrate. And those investors should also be raising their cash in the air to buy a stock offering a 5-6% yield with such an announcement.
Image source
What is up with Enbridge (NYSE:ENB) since the beginning of the year, then? Management announced 10-12% CAGR dividend growth through 2024 last year. Even better, it has met its promise so far in 2017 and 2018. Still, the stock is down by more than 20% since the beginning of 2018. The path to double-digit dividend growth seems compromised in many ways.
Before I show you the light, let’s take a walk on the dark side. I’ll tell you what bears are whispering in the woods. Definitely, they think management is about to do another Kinder Morgan (KMI) story here. Do you remember this CEO announcing that everything was fine while hiding its dividend scissors behind his back? This is what we call being “Kindered.”
1. Enbridge's many projects won’t happen
Image source
In 2017, Enbridge rose over $14 billion in capital and funded for $12 billion in projects. Management expects to keep such pace in the upcoming years to support its generous dividend policy. ENB put $7 billion in projects on the table for 2018. Those are crucial to support its cash flow, for e.g. its dividend. While this shouldn’t be a problem, many investors are worried about 2019. Next year, ENB expects to fulfill $13 billion in projects, including a $7 billion investment in Line 3 replacement.
Source: ENB investor presentation
While the Line 3 replacement project received many regulatory approvals so far, there are opponents among local communities. Such opposition could delay this project and raise its costs significantly. In the worst-case scenario, Enbridge could face similar problems to what happened to Energy Transfer Partners (ETP) in 2016 when its pipeline project was blown off the earth. This would have a catastrophic effect on ENB’s future cash flow and would most probably force management to revise its dividend policy.
Finally, if oil demand remains stable or weakens, Enbridge could end up with full of projects on paper, but no demand to activate them.
2. Enbridge is borrowing money like it was Tesla on steroids
Source: ycharts
OK, I’m exaggerating here; Tesla (TSLA) is a lot worse than Enbridge in regards to debt. Nonetheless, after the acquisition of Spectra (SEP), ENB’s debt reached unprecedented levels. Leverage is good to a certain level and we all know that pipelines are capital-intensive businesses. This situation becomes toxic when it is mixed with a generous dividend payment.
Enbridge requires lots of money to fund its projects ($22 billion CAD through 2020), but needs even more money to pay its shareholders. This means ENB’s quest for money isn’t over just yet.
Source: ENB investors’ presentation
Then again, the whole point is to fund those projects and let them bring the cash home. If this scenario happens, there won’t be any problems. In the meantime, this is what creates such volatility in the market.
3. The FERC is trying to put another nail in the coffin
Enbridge’s situation isn’t catastrophic, but we could qualify it as “delicate.” Back in March, the Federal Energy Regulatory Commission came up with another ruling that could hurt ENB’s future cash flow. This ruling disallows income tax recovery on cost-of-service pipelines. While this scared many investors in the first place, ENB was fast to issue a statement explaining how this new potential law will have minimal impact on its business:
Enbridge Energy Partners, L.P. derives a portion of its revenue from a Facility Surcharge Mechanism that applies cost of service tariffs which would be impacted by this policy change. As a result of lower tax rates under US Tax Reform, EEP previously guided to a decrease in distributable cash flow (DCF) of $55 million for 2018. This new FERC policy would cause a further decrease to DCF of roughly $80 million on an annual basis, or roughly $60 million on a prorated basis in 2018.
Under the International Joint Toll mechanism, reductions in the EEP tariff will create an offsetting revenue increase on the Canadian Mainline system owned by Enbridge Income Fund Holdings Inc. (ENF). Financial guidance at ENF remains unchanged; however, this could provide a further tailwind for financial results. The combined impact at both EEP and ENF are offsetting for Enbridge on a consolidated basis.
The problem with this news is that it falls during a perfect storm. Hence, the stock kept dropping.
Why do I keep my Enbridge shares?
I’m not known to hold many high yielders in my portfolio. In fact, if you follow my articles on Seeking Alpha (join over 17,000 serious investors following me, we are going to have fun!), you will notice that I’m more about dividend growth than dividend yield. I usually pick most of my stock ideas from the Dividend Achievers list. Therefore, what is the point of holding ENB?
1. Enbridge's divided history is stellar
Enbridge is one of the rare companies showing a combination of both high yield and strong dividend growth perspectives. Enbridge hasn’t just hopped on the dividend growth train recently to please investors. Over the past 20 years, it shows a double-digit dividend growth policy:
Source: ENB website
Management shows a long history of dividend payment (64 years) and has never failed its shareholders (not like Kinder). I’m not saying it’s impossible that the dividend growth plan fails, but I’m saying it is unlikely. To support this short-term hurdle, management even decided to sell non-core assets for $8 billion CAD to please credit agencies and reassure shareholders. The dividend has been increased in 2018 and will continue to hike higher.
2. Enbridge operates a perfect business model the smart way
What is nice about pipelines is that they are like toll roads. The only difference is that you have no choice to take that road and pay the toll if you want to travel. Enbridge operates the longest pipeline in North America. The best part is that most Enbridge clients enter in 20-25-year transportation contracts. Therefore, no matter what happens, there are always people paying the toll. The cash flow is easy to predict in the future, which leads to steady dividend growth.
After the purchase of Spectra, two-thirds of ENB's earnings is generated through oil sand (liquid pipelines) distribution while the other one-third is coming from natural gas transmission.
Enbridge is constantly growing its distribution network based on demand. While some investors could be worried about short-term fluctuation, energy demand isn’t ready to fall over the long term. Enbridge is a leader in a “money printing” business.
3. Current valuation screams Buy! through all windows
Since Enbridge’s business model is all about printing money and distributing it to its shareholders, it makes sense to use the dividend discount model to get an idea of ENB shares' fair value. In order to be conservative, I’ve used an 8% CAGR for the first 10 years. This is 2-4% below what management expects through 2024. As a terminal rate, I also drop it to 5%. Since the business shows risks (as explained above), I’ve used a discount rate of 10%.
Input Descriptions for 15-Cell Matrix | INPUTS | |||
Enter Recent Annual Dividend Payment: | $2.13 | |||
Enter Expected Dividend Growth Rate Years 1-10: | 8.00% | |||
Enter Expected Terminal Dividend Growth Rate: | 5.00% | |||
Enter Discount Rate: | 10.00% | |||
Discount Rate (Horizontal) | ||||
Margin of Safety | 9.00% | 10.00% | 11.00% | |
20% Premium | $85.41 | $67.75 | $56.01 | |
10% Premium | $78.29 | $62.11 | $51.34 | |
Intrinsic Value | $71.18 | $56.46 | $46.67 | |
10% Discount | $64.06 | $50.81 | $42.01 | |
20% Discount | $56.94 | $45.17 | $37.34 | |
Please read the Dividend Discount Model limitations to fully understand my calculations.
At a discount rate of 10%, ENB's fair value stands at $56.46 USD. Even if I’m being difficult and ask for a 12% return, the fair value would be $39.71. As the stock is trading in the low $30s, it’s probably one of the best deals around the market now.
Final Thought
If Enbridge’s management had decided to keep more cash flow in the bank and pay down its debt instead of sharing the wealth with investors, we would not see the stock down that much. The long history of dividend growth has created a cash flow burden during challenging times.
This is often the moment to pick up a falling knife as the company can definitely navigate throughout those high tides and finally deliver its payments to shareholders. I’m keeping my shares and I even bought some more on April 3rd.
Seriously, if you made it this far, it’s because you liked what you read. Don’t be a stranger; leave a comment and tell me what you think! I’m asking you one more thing; click on “Follow” button (it’s orange, you can’t miss it!) and you will get notified each time I write a great piece like this one.
Disclosure: I do hold ENB in my DividendStocksRock portfolios.
Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.
Many investors focus on dividend yield or dividend history. I respectfully think they’re making a mistake. While both metrics are important, aiming at companies that have and show the ability to continue raising their dividend by high single-digit to double-digit numbers will make your portfolio outperform others. When a company pushes its dividend so fast, it’s because it is also growing their revenues and earnings. Isn’t this the fundamental of investing – finding strong companies that will grow in the future? If you are looking for a great combination of dividend and growth, check out my picks at Dividend Growth Rocks.
This article was written by
Analyst’s Disclosure: I am/we are long ENB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (95)
Cheers,
Mike
ENB appears ready to roll up EEP/EEQ.
Then ENB also appears to need more cash to improve credit rating...and therefore lower cost of capital. So ENB will try to sell some of their 83% stake in SEP. All this is in addition to selling off some assets as has been recently announced.
Since SEP, EEP, EEQ share prices are all at all-time lows. This helps ENB with being able to buy EEP and EEQ cheaply and accretive to ENB dcf(distributive cash flow per share).
The problem for ENB is SEP share price being too low. Thus ENB will try to maintain it's dividend increase history going forward. But like ENB has always done before management will disappoint some SEP investors with bad news about no increase in distribution next year. This bad news is probably already factored into SEP's share price.
ENB will issue SEP equity and thus dilute the public float. It will not be accretive for SEP investors, but ENB will for now be able to increase their dividend next year.
This is what the Wells Fargo report shows. So everyone can take this for whatever it is worth to you.
All this is to lower ENB consolidated debt to EBITDA number from 6.6 to 4.9.
For if ENB can pull this off, their credit rating will be upgraded. IMHO
I am waiting for the final result announcement around July....to see the stock fly high...
LONG ~ ENB
In regards to the renewable energy assets sale, I think ENB just got caught by credit agencies and nervous shareholders and management must please them before going further with their plan.
These were good assets (especially looking for the long haul), but ENB must focus on getting its 2018-2020 projects in place before it can think of expanding to renewable energy at the moment. I wish It could have kept those...
MLP which has really taken a hit for me in the past year while it maintains a 10% qtrly div. Anyone have some perspective on that specifically or that sector generally? Just weighing how long before it may rebound
To be honest, I'm not a big fan of Laurentian Bank. I've done a detailed analysis for Dividend Stocks Rocks not too long ago. The bank has always had a hard time establish a long term growth strategy. It keeps going from one strategy to another (e.g. opening tons of branches, then cutting them down, trying B2b, now eyeing wealth management, etc). I don't think it has what it needs to compete against National Bank for example.
sorry for that.
I'm out of cash (put everything left on ENB), but BCE and Telus are definitely long term hold (read hold forever) dividend paying stocks.
Cheers,
Mike.
Cheers,
Mike
I'm French Canadian and I have all my articles edited. For some reasons, there are a few grammar errors here and there. I do my best to keep them to a minimum.
