Enbridge: Why I'm Not Buying This 7% Yield

Summary

• ENB is one of the largest pipeline operators in the continent.
• The company has been able to boost profitability without increasing leverage.
• The stock trades at a generous 7% dividend yield, but at 17 times free cash flow.
• I give my verdict if the stock is a buy, sell, or hold.
• I do much more than just articles at Best Of Breed: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

Photo by Maksim Safaniuk/iStock via Getty Images

Enbridge (NYSE:ENB) has seen a solid recovery since crashing last year. Still, the stock is yielding 7%, which is arguably high when considering ENB’s high growth rate. In this article, I explain why ENB has been one of the best pipeline operators in the continent. Leverage remains high, but if the company can continue executing, then the robust growth rates may more than make up for it. I give my final verdict regarding whether the stock is a buy, sell, or hold.

Enbridge Stock History

As the world came to a stand still, ENB saw its stock crash in March of 2020.

(Seeking Alpha)

Since then, the stock has almost fully recovered to pre-pandemic levels. It appears that optimism regarding vaccine distribution has investors hoping for a swift rebound in the energy sector.

Enbridge: Pipeline Giant

ENB is one of the largest pipeline giants in the continent, as it transports 25% of crude oil and 20% of natural gas in North America.

(Investor Presentation)

ENB has gradually reduced its exposure to crude oil liquids and increased its exposure to natural gas, now totaling 43% of income in 2020.

(Investor Presentation)

That’s important to point out, because whereas crude oil seems to face strong secular headwinds from an ESG perspective, natural gas remains considered a relatively carbon-friendly alternative.

(Kinder Morgan Investor Presentation)

As a pipeline operator, ENB is one of those stocks frequently called the “toll roads” of the energy sector. The company was able to prove that title during the pandemic, as it was able to more or less maintain revenues in spite of a crash in the broader energy market.

(Investor Presentation)

How does one go about determining if ENB is a high quality operator? I use two metrics: return on assets (‘ROA’) and leverage. By looking at ROA based on distributable cash flow (‘DCF’) over time, we can see if the company is able to maintain profitability on its asset base. Stable or increasing ROA implies that profitability is increasing, with growth projects adding to that profitability. If ROA is decreasing, then that implies that profitability is decreasing and growth projects are merely hiding underlying weakness. ENB has managed to substantially grow ROA over the last 5 years.

(Chart by Best of Breed, data from annual filings)

I next look at leverage as measured by debt to EBITDA. It is important for leverage to be stable or declining because that implies that management is executing on project expectations and that the growing ROA is not simply due to increasing leverage. As we can see below, ENB has gradually reduced debt to EBITDA year after year.

(Chart by Best of Breed, data from annual filings)

Lower quality operators would see ROA decline and debt to EBITDA increase - ENB is solidly on the right side of both metrics. ENB projects the growth to continue, with 5-7% DCF per share growth through 2023.

(Investor Presentation)

Is Enbridge Stock Dividend Safe?

ENB yields 7% and thus is likely to be targeted by dividend investors. The main topic in mind might be: is the dividend safe? There’s several components to that answer. First, ENB’s dividend is covered by DCF with a 56% DCF payout ratio. However, ENB is highly capital intensive as it needs to invest in growth projects to drive growth.

(Investor Presentation)

Based on free cash flow, ENB has a 150% payout ratio, which may appear dangerously high. Furthermore, ENB’s leverage is rather high at 4.7 times debt to EBITDA.

(Investor Presentation)

I would feel more comfortable if ENB brought leverage down closer to the 3.5 times range seen at Enterprise Product Partners (EPD) and also improved its free cash flow payout ratio. However, one must also take into account ENB’s great track record. As discussed previously, ENB historically has strongly executed on growth projects, which has enabled it to earn BBB+ or equivalent credit ratings in spite of its high leverage.

(Investor Presentation)

If everything goes as planned, then ENB likely will be able to continue funding the free cash flow shortfall with excess debt because as it grows EBITDA, its capacity for debt also increases in line with its debt to EBITDA ratio.

Is Enbridge Stock A Buy?

The value proposition for ENB is quite simple: you get the current 7% yield, then adding the 5-7% growth suggests ~13% total returns excluding multiple expansion.

(Investor Presentation)

ENB has guided 2021 to see DCF of $4.85 per share at the midpoint. Shares trade at less than 8 times that number. However, because ENB must heavily invest in growth projects to drive growth, I believe that DCF multiples are useless and it is much better to value the stock on the basis of free cash flow. ENB trades at 17 times free cash flow - a markedly higher number than DCF. At a 5-7% growth rate, shares appear more or less fairly valued. However, the higher leverage position adds tail-end risk in the event that its counterparties are unable to maintain its contracts, or if it is unable to invest in accretive growth. While ENB touts its 1% annual escalators, I am skeptical of its ability to push those escalators if demand for its assets does not consistently increase. I would be more interested in ENB if it traded for 10 times free cash flow - roughly 40% lower. At that multiple, I believe the secular headwind risks would be better priced in. Unfortunately, the stock might not reach that valuation unless the secular headwinds come into full force.

Conclusion

ENB appears to be a very high quality pipeline operator as evidenced by its ability to increase profitability metrics without boosting leverage. The company has guided for solid growth over the next few years as it completes more growth projects. However, the high leverage load increases its downside risk, and shares aren’t that cheap when viewed based on free cash flow. I rate shares a hold pending an improvement in the risk reward proposition.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Comments

[ahimsaka]

keep in mind, folks, Enbridge operates throughout North America, thanks in part to the consolidation of Spectra Energy. Better to think of Enbridge as a North American company, rather than as a "Canadian" or "American" enterprise, even if the HQ is in Canada.
In their own words:

"We operate across North America, fueling the economy and people’s quality of life. We move about 25% of the crude oil produced in North America, we transport nearly 20% of the natural gas consumed in the U.S., and we operate North America’s third-largest natural gas utility by consumer count. Enbridge was an early investor in renewable energy, and we have a growing offshore wind portfolio."

A picture is worth 1,000 words:

www.enbridge.com/...

Long ENB

[houtex]

@ahimsaka
Good point. ENB actually gets a majority of revenues from, and has a majority of its PP&E in, the United States.

[ahimsaka]

@houtex good info. I suspected that was likely the case, but didn't have the time to look it up!

[GreenguyMN]

Having emigrated to the U.S. from canada and having most of my family still living in canada, i am well aware of the anti-yank sentiment that many Canadians harbor. I just don’t think it’s usefull to express those thoughts in an investment forum. And lets not forget that through some of Endbridge’s acquisitions, there many that feel kindered.

[Money Talks!]

@GreenguyMN, I agree, it's not useful, whether you'ere Canadian or else. They are the greatest. Just ask them.

[GreenguyMN]

Catphone:
Nothing makes a canadian feel better than a little yank bashing, though you usually need a few shots of rye to get that going. Kind of negates any investment case you may have been trying to make.

[Money Talks!]

@GreenguyMN, and you think only Canadians think this of the Yanks❓ Sure, no worries, everything's gonna be all right!

[catphone]

Thanks for an article that isn't just another "wHY i'M bUYiNg eNb hAnd OvER fisT! type of thing. It's sooo important to read bearish articles (not that you seem bearish), when you're bullish on something.

I'm a Canadian who plans on holding ENB indefinitely in my registered accounts and just collecting my 7% along the way. I'm not too concerned about price appreciation for this one.

You can compare the numbers between midstreamers all you want, and it is relevant. But in my mind Enbridge is the least sketchy of the big players.

ET - How do you feel when you read the name "Kelcy Warren"?
EPD - How do you feel knowing more than a third of it is owned by filthy rich insiders? Do you think these people have any grasp of our lived reality? Do you think they even care?
KM - How's that been going for you this last decade, Mr. Kinder?

And this is where I'll lose the Americans, but so be it. Americans are considered to be untrustworthy these days by the rest of the world. It wasn't always like that. Are you an American who balks at this? I'm sorry but it's true. Who would be considered even less trustworthy than an American oil executive? A tobacco exec, probably a pharma exec, a tech bro maybe? Why would you want to own something like that if there are arguably better options?

Don't worry about withholding taxes. The USD is as good as worthless. Dead man walking. The politicians know this. Even they're not THAT clueless. They're lying like it's going out of style. They can't admit the truth. I get it, and I almost feel for them.

Even if you don't recoup your 15% withholding tax (which you easily can), you'll still be way ahead if you divest into foreign currencies. In the past 1 year the USD has fallen 12% compared to the CAD. That means the effective w/h tax today is 3%. Once that 12 passes 15, you'll have a net gain on the currency conversion.

I know that's some harsh, even mean stuff. But investing isn't about nice feelings and filling your heart with love and joy. You have to look for as much truth as you can find even if it's ugly, and then when you think you've found the truth, look even harder. Numbers are a huge part of that, but so are instincts and grasping what's actually going on in the world.

All of us in North America are on a sinking ship that broke in the middle. The Americans opted for credit cards instead of lifeboats. They said something about "both being made of plastic, so what's the difference?" Now it's every man for themselves, and the executive class sure as shit won't be sticking around to help.

My real point being, get out of US dollars and get into foreign, hard asset, dividend paying stocks. Get into gold and gold miners. Base metals. Fertilizer. Anything with actual value and real earnings. That's where the gains are going to be over the next decade and likely even longer. Enbridge would be a fine start.

[Money Talks!]

@catphone, no truer words were ever spoken.

[Douglas Payne]

Juicy dividend .. funded by ARBOR ability to generate INCOME, PROFIT and MORE DIVIDENDS including business expansion.. RIGHT?

[Money Talks!]

Why I did buy: up 27% + the juicy dividend!

[ckarabin]

It's interesting that ET has serious debt problems accord to some, at a EBITDA to debt ratio of 4.7x, yet ENB is considered (by many, but not this author) to be a great buy without debt problems aith a 4.7x ratio. Hmmm

[houtex]

@ckarabin
I’m neither here nor there on Enbridge, but they do have a slightly different contract profile than ET does. Longer pipes, more cost-of-service stuff, less G&P, etc. Does that mean debt isn’t a “problem”? I don’t know, but the entities are quite different when you look at the operations.

[locum2]

That dividend yield is before Canada takes almost half. For a small US investor, you’re better off with US based MLPs.

[Bag Man]

@locum2 Keep it in a retirement account and there is no Canada withholding tax. Keep it in a taxable account and you can claim a tax credit (form 1116) for the withholding tax so it costs you nothing.

[ahimsaka]

@locum2
No, Canada's withholding tax is 15% and is waived, ie, zero, in Americans' IRA accounts.
The foreign taxes paid in your taxable account can be recouped as a tax credit on your 1040 return. It's very easy with the TurboTax software. Have been doing it for years and enjoying the big dividend from this high quality company.

[Carlos-Mendoza]

@ahimsaka agree....I use H&R Block. SW program handles it....so this withholding tax thing is a real misconception.

[Hungry for Knowledge]

Thank you.
I'm glad I own it at a 40% lower price than it currently trades, now that I've read your article.

[Julian Lin]

@Hungry for Knowledge Great buy!

[Qichar]

This is a great article. I would need to do a deeper dive into the expiration dates of its current debt (bonds) in order to make a better assessment of vulnerability due to rising interest rates. But in general, highly leveraged companies make me pause right now because I think we're about to face a large spike in interest rates. The era of cheap debt will not last forever as the economy continues to rebound. Therefore, companies like ENB are going to tighter liquidity issues since refinancing will result in higher debt interest load as time goes on.

[houtex]

@Qichar
Most pipeline contracts have inflation escalators. And for spot volumes and contract renewals, those will tend to follow inflation too as, well, that’s what inflation is. So if rising rates are matched by rising inflation, that will ease, not exacerbate the debt burden for companies with fixed-rate debt complexes. I looked quickly through the annual report too and clearly the majority of debt obligations are fixed rate, though I didn’t calculate the exact number.

[Qichar]

@houtex I agree with your statement about revenues scaling with inflation. I also agree about fixed rate debt. What I do not know is if ENB has issued your standard corporate bonds that have an expiration date when the principal is due in full. If there is a large group of coupons like that expiring in the next couple of years, that might force refinancing at higher rates.

I own a different stock, Unit (towers, fiber, etc.) that just put up some senior notes for 4.5%. I really liked the move because it shows they are thinking ahead by locking in low rates while they can.

[howard2374]

@Qichar UNIT has been an interesting past few years. I currently hold no UNIT shares, but have been watching it.

[GrayBeard Retirement]

Judging dividend safety by FCF yes, but using it for valuation is unusual.
Seems a bit punitive to me.

Also, if you were going to use price to FCF, a look at historical reference would have been appropriate before drawing a conclusion.

GBR

[Will104]

@GrayBeard Retirement

If the capex is genuine growth capex and not defensive/maintenance then it should not be deducted to get to a valuation

[Julian Lin]

@GrayBeard Retirement One can't use DCF for valuation because the growth assumes that basically all of retained cash flows are reinvested for growth. (that would be double counting)

[GrayBeard Retirement]

@Julian Lin Kind of like EPS for a corporation.......

GBR

[billul60]

if you hold canadian stocks in an IRA their is no tax.U.S. has an agreement with canada

[RickcarinoNYC]

You will loose 20% in dividend tax right at front. $500 in dividend, I only got $400 & you pay US tax on it. Good Bye all Canadian Investments. I’m very happy with US dividends. Canadian investments are worse on universe. Target wiped out 6 Billions, When closing of Canadian stores.

[Jeff Swan]

@RickcarinoNYC Agreed. I regretfully bought VET after the guys at HDO recommended it. Soon after, they eliminated the dividend. I'll still with US based companies.

[TechnicalEntry]

@RickcarinoNYC The US similarly withholds 20% of dividends for Canadian investors, so don’t get your undies in a twist that we’re out to screw you. It’s a two way street.

Canada and the US do have a reciprocal agreement to not withhold the 20% if the investment is held in a retirement account.

As for Target, that debacle was entirely self inflicted on their part. They opened the stores here and they were a mismanaged joke. Half the shelves were literally empty, no products to fill them. They opened the stores but didn’t bother to create a supply chain to fill them. It was like a going out of business sale, but it was actually their grand opening. Totally bizarre. No products, so no customers, it’s pretty simple.

[RickcarinoNYC]

@TechnicalEntry
This is reciprocal and that is fine, US investors stay invested in US and Canadians do it there. I commented on my experience. I try to start import & distribution in Canada, even before start of business, Revenue dept send me advance pay notice to deposit $40 k towards GST expected on first import that I did not even placed order as guarantee tax against possible import. I got alarmed and immediately discontinue the idea. Taxes are high and policies are anti foreign investments. This is a personal experience. Canadian consumers are also penny savers, they rather do business with USA. One can find lot more great companies here to invest.

[D. Rockefeller]

One other thing is they deduct a tax from US investors reducing the dividend amount right up front. Canadian tax, Federal tax, state tax, even though it's listed on the NYSE.

[No Drip]

The tax they withheld you get back when you file your taxes. The IRS applies it to what you owe.

[TechnicalEntry]

@D. Rockefeller The US does the exact same thing to Canadians on US dividends.

If they are held in a retirement account, neither country withholds the tax due to a reciprocal agreement, however.

[locum2]

@No Drip, sorry no. The US IRS does not reimburse you for foreign taxes paid.

[Kenmare]

I made good money on ENB a couple of times because of a cyclicality pattern I have observed. When it goes to $28 or further south, I buy and then sell at around $35. Done that twice now to good effect.

[Julian Lin]

@Kenmare Yes - a better entry point may be warranted

[ahimsaka]

For a good understanding of Enbridge, take a look at their most recent investor presentation, here:

www.enbridge.com/...

What strikes me is that investors can get such a high yield (and dividend increases) from such a large, stable, investment grade company. To find a yield of 7%, or anything close to that in this market, you usually have to stoop pretty low on the quality scale. With ENB, you have the yield AND high quality. ENB looks like a gift at these prices. Long ENB

Remember: No K-1 forms. No Canadian withholding tax in IRA accounts. The 15% withholding tax in taxable accounts can be recovered by claiming a credit for foreign taxes paid on your 1040. The process is (unnecessarily) complex but very easy with software like TurboTax Premier. I look at my foreign taxes withheld as a portion of my quarterly estimated tax payments, as the amounts withheld reduce my final tax bill dollar for dollar. (I am not a tax expert so not qualified to give tax advice. I can only share my experience for what that is worth).

[jack kreg]

@ahimsaka agree, except the K1 is worth its weight in gold, with Biden tax hikes, the tax deferral aspects of MLP's is amazing, aka meaning how long will it be before MLP's are turned into green new deal revenues,
aka a nationalized pipeline system, run by the Sierra Club, a guarantee to end US energy independence, putting US back under Middle Eastern and now Putin, for American Energy needs.

[ahimsaka]

@jack kreg
are you aware that the MLP tax "deferral" can turn into a tax bill, at your highest marginal rate, if you sell your MLP or it is sold out from under you, as happened at Kinder Morgan Energy Partners, among others, when they converted to C-Corps? Go to tax packagesupport.com and pull up a K-1 from one of your MLPs. Go to the far right of the box that has your name in it, to where it says Actions (?) To the right you will see three little dots, lined up vertically. Click on those. In the box that opens, click on "gain loss calculations". Click on the blue box that says "sell all units". This will show you what your tax bill would have been had you sold all your units on the last day of 2020. See the amount in "ordinary gain"? That's what you would have been taxed on at your highest marginal rate (not the preferred rate for capital gains or dividends). The MLP tax deferral turns into a tax deathtrap if you sell you units, or your MLP converts to a C-Corp, as the IRS "recaptures" all your previous tax deferrals. I hope and pray they don't do away with stepped up basis so I can hold my MLPs until death and bypass the "recapture" tax.
If they do away with it, at least I won't be around to stress over the enormous
tax bill. That will be left to my executor/successor trustee.

[PlumberMD]

@ahimsaka From my understanding increases in unit price would be taxed at regular Cap Gains rates and distributions taxed at highest marginal rates. I just went into Taxpackagesupport.com and the calculator is very helpful. Just as you said “Ordinary Gain” represent the distributions that will be taxed as Income. Thank you very helpful!

[Chancer]

"...from an ESG perspective, natural gas remains considered a relatively carbon-friendly alternative."

The problem with this is that ESG is part of the political agenda of the Left and NG is NOT. The Left hates NG almost as much as oil. If the left wants to end NG use, it does not matter if it is "carbon friendly", nor if this harms citizens, nor if that is irrational.

I ask myself, if my NG investment is wiped out to zero, how many years of dividends does it take to replace my investment. For ENB, up to 14 years: 100/7=14.29. That is too long to risk. I need higher yields for NG.

I own 2 NG pipeline stocks with yields of 20-21%, which pays my investment back in 5 years. I do not plan to add shares any more than the ROC I receive from dividends annually. That will maintain my yield and average cost.

[Ray Lopez]

@Chancer Also long Enbridge. IMO the economist Jevons is the reason, even if crude no longer is used in transportation, the future of fossil fuels is bright. Jevons, a 19th century brilliant mind, stated with respect to the fossil fuel coal that the more cheaper it becomes, the more of it is used, and thus even if oil drops due to EV usage, other uses (like feedstock for plastics) will keep the demand high. Plus you have the rest of the world that's not into trendy green themes.

[houtex]

@Ray Lopez
If there is no more demand for hydrocarbons for transportation / btu value, you’re right that there are other uses, but every single energy equity price —every last one of them—will go to zero. You can’t cut demand by more than 50% and expect companies to survive.

The good news is that transportation / btu value demand isn’t going to zero, but people shouldn’t be under the impression that other sources of demand are enough to keep everything afloat.

[Ray Lopez]

@houtex I'm also long the energy sector via the energy ETF XLE. As for demand going down, companies adjust, typically by cutting costs and firing people. Life goes on.

[maudie]

Benzinga shows Credit Suisse@ 50.0; Wells Fargo@46.0; RBC Capital@58 price target average 40% upside.🤷🏻‍♀️

[Charliedon'tsurf]

Long EPD

[Veritas1010]

@Julian Lin,

Well done analysis, thank you.

One reason I never pulled the trigger myself - though regret not doing so at more opportune Covid scare levels.

Same argument for $TRP (TC)? For me, yes.