A welder works on a pipeline. Berkut_34
Those who have followed me over the years know that I believe the next couple of decades will be solid for the midstream industry. My rationale for this belief hinges on oil and gas being life-sustaining commodities with no immediate substitutes.
Enbridge 2024 Investor Day Presentation
As I noted in my article on ONEOK (OKE) earlier this week, demand for these commodities has nowhere to go but up in the next 20-plus years. This is because building out a growing global middle class will require access to affordable and reliable energy.
That means all forms of energy will continue to be in demand for the foreseeable future. According to S&P Global (SPGI) Commodity Insights' forecast illustrated above, global absolute demand for energy is expected to rise by 12% between now and 2040.
For these reasons, my investment holdings within the industry include Energy Transfer (ET), Enterprise Products Partners (EPD), Kinder Morgan (KMI), MPLX LP (MPLX), and ONEOK (OKE).
One stock that I will be adding to this group with a starting weighting of approximately 1% within the next week is Enbridge (NYSE:ENB). When I last covered the company in December, I appreciated its status as North America's largest midstream company.
In the last three months, I have only become more convinced by the bullish case to be made for the company. Today, I will be revisiting Enbridge's fundamentals via an examination of the fourth-quarter operating results shared last month. Along with a discussion of valuation, that is why I am maintaining my buy rating right now.
Dividend Kings Zen Research Terminal
Since I last covered Enbridge, shares have edged 3% higher. That has brought the yield down from 7.7% to 7.6%. However, the yield on 10-year U.S. Treasury notes has also come down 10 basis points from 4.2% to 4.1%. Thus, the investment spread between Enbridge and 10-year U.S. Treasury notes has remained at about 350 basis points.
As a dividend growth investor, I also have confidence in the safety of the income that the company will provide for my portfolio. That's because Enbridge's 69% DCF payout ratio is comfortably less than the 83% DCF payout ratio that rating agencies have as the industry-safe standard for midstream.
The company's 48% debt-to-capital ratio is also better than the 60% debt-to-capital ratio that rating agencies desire from the industry. This suggests the company is well-capitalized, which is why S&P rates Enbridge's debt BBB+ on a stable outlook. According to data from rating agencies, that puts the risk of the company going out of business by 2054 at 5%.
For these reasons, the Zen Research Terminal projects the likelihood of a dividend cut in the next average recession of 0.5%. If the next recession was severe, the probability would increase to 2%. For additional insight, these are both the minimum allowed values for the chances of a dividend cut within the Zen Research Terminal.
Dividend Kings Zen Research Terminal
Enbridge remains a compelling value at this time. The company's five-year average dividend yield of 6.7% implies a fair value of just shy of $41 a share. Additionally, Enbridge's P/OCF ratio is 8.4 for the current year, which is below its normal P/OCF ratio of 9.3. That points to a fair value of nearly $41 a share as well. In my opinion, these fair values are reasonable because the company's fundamentals look to be intact versus past years.
My independent analysis shows shares of Enbridge to be reasonably discounted to fair value as well. Using the following inputs into the dividend discount model, here is how I arrive at my fair value just north of $40 a share: A $2.72 annualized dividend per share in U.S. Dollars (based on the CAD to USD exchange rates on March 8, 2024), a 3.25% annual dividend growth rate, and a 10% discount rate (my minimum annual total return target). I believe this dividend growth rate could even be conservative based on the company's medium-term outlook of 5% annual DCF per share growth and a manageable payout ratio.
Averaging out these fair values, shares of Enbridge are priced 12% below fair value from the current $36 share price. If the company returns to fair value and grows as anticipated, here are the total returns that it could generate in the coming decade without an annual valuation multiple expansion of 1.3%:
- 7.6% yield + 3.3% FactSet Research annual growth consensus = 10.9% annual total return potential or a 181% 10-year cumulative total return versus the 10% annual total return potential of the S&P 500 or a 159% 10-year cumulative total return
A Solid Fourth Quarter And Steady Growth Ahead
Enbridge Q4 2023 Earnings Press Release
In yet another quarter, Enbridge delivered results to shareholders that I found to be impressive. The company set several operational and financial records for the fourth quarter ended Dec. 31, 2023.
Enbridge's adjusted EBITDA climbed 5% higher year-over-year to $4.1 billion CAD in the fourth quarter. The midstream operator's DCF per share fell by 2.3% over the year-ago period to 1.29 CAD during the quarter.
However, that was because of the 102.9 million shares that were recently issued to begin pre-funding the acquisition of Dominion Energy's (D) natural gas utility businesses.
On that note, Enbridge sold its 50% stake in Alliance Pipeline and its 42.7% interest in Aux Sable to Pembina Pipeline Corporation (PBA) for 3.1 billion CAD. The former was sold for 11 times projected 2024 EBITDA and the latter was disposed of at 7X projected 2024 EBITDA.
Share issuances and these asset sales have gotten Enbridge's natural gas utility acquisitions to about 85% funded. The company expects that all three of these natural gas utility acquisitions will be completed in 2024. Stripping out the share issuances, Enbridge's total DCF grew at a year-over-year rate of 2.6% to 2.7 billion CAD for the fourth quarter.
What was behind these respectable operating results in the fourth quarter?
According to CEO Greg Ebel's opening remarks during the Q4 2023 Earnings Call, the mainline transported more than 3.2 million barrels per day during the fourth quarter.
In the Permian Basin, higher export demand resulted in record crude oil volumes through Enbridge's Gray Oak pipeline and its Ingleside export terminal per Ebel.
Enbridge 2024 Investor Day Presentation
CFO Pat Murray reiterated Enbridge's previous guidance for 2024 during the Q4 2023 Earnings Call. This called for a midpoint DCF per share of 5.60 CAD (5.40 to 5.80) or a 2.2% growth rate over the 5.48 base in 2023. EBITDA is expected to be 16.9 billion CAD at the midpoint (16.6 billion to 17.2 billion). That would be a 2.7% year-over-year growth rate versus the 16.5 billion CAD posted in 2023.
It's important to note that this guidance does not include the U.S. gas utilities acquisitions that will be closed throughout the year. As those close, growth could be even better than forecasted.
Aside from the strength of the existing business, Enbridge also predicts that 4 billion CAD of projects will be completed in 2024. That includes a 200 million CAD expansion project for Ingleside, the 500 million CAD Venice gas transmission extension project, and several renewable projects for a combined 1.1 billion CAD. This is behind the growth that is predicted in 2024.
Looking out a few years, Enbridge thinks that it can return to 5% DCF per share growth annually. I think this is reasonable because of its existing businesses and the fact that it added 10 billion CAD to its growth backlog in 2023 alone per Ebel.
All the while, this growth is rather predictable. That's because according to Ebel, 95%+ of Enbridge's customer base is investment grade, and under 10% of its debt is vulnerable to floating rates.
On the balance sheet side, the company remains financially healthy. Enbridge's debt to EBITDA including the asset sales was 4.1x per Ebel. That's below the company's targeted leverage ratio of 4.5 to 5x (unless otherwise noted or hyperlinked, all details were sourced from Enbridge's Q4 2023 Earnings Press Release and Enbridge's 2024 Investor Day Presentation).
No End In Sight To Dividend Growth
As I noted in my previous article, Enbridge upped its quarterly dividend per share by 3.1% to 0.915 CAD in November. This marked the 29th consecutive year that the company grew its dividend.
In the coming years, there should be room to grow the dividend further. After all, Enbridge's targeted DCF payout ratio is between 60% and 70%. Assuming the company doles out 3.66 CAD in 2024 and a midpoint DCF per share of 5.60 CAD, the DCF payout ratio would be firmly within this range, at 65.4%.
Risks To Consider
Enbridge is a high-quality company that is essential to the quality of life of tens of millions of people, but it still faces risks.
One of the more notable risks to the company is operational. Enbridge's growth story partially depends on its billions of CAD in growth projects being completed on time and within budget. Any cost overruns or project delays could unfavorably impact growth.
Another risk is the potential for the company's IT networks to be breached. If the breach was significant enough, Enbridge's operations could be meaningfully disrupted. That would harm the company's operating results and could damage its reputation.
As I also discussed in my previous article, the company's pipelines and distribution systems are located around densely populated areas. If there was a pipeline explosion or a leak, many people could be affected. That could result in litigation against Enbridge, which could hurt cash flows.
Summary: Enbridge Is A No-Brainer Buy For Me
Enbridge's starting income is attractive and well-supported by DCF. The company's fundamentals also look like they can sustain DCF growth to fuel continued dividend growth. Enbridge's balance sheet also doesn't look like it will impede capital returns to shareholders.
Thanks to these elements, I am excited to be opening a position in the company in the coming days and am keeping my buy rating.
