Enbridge (ENB): 6.18% return, but where is the catch?

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Enbridge (NYSE: ENB) is a Canadian pipeline stock well known for its 6.18% yield. The stock has performed above average for many years, due to a combination of dividend increases and weak capital gains. The title has spent most of the fall of the past five years, after emerging from a very long downtrend only this year.

Enbridge 5-Year Chart

Enbridge 5-Year Chart (looking for Alpha Quant)

Many income investors are attracted to the performance of ENB. The S&P 500 returns just 1.62%, so ENB returns nearly four times the average stock. If you invest $100,000 in ENB, you get $6,180 in annual dividends, assuming the payout doesn’t change. But the payment is changing – in a good way. Enbridge has increased its dividend by 10% CAGR over the past 27 years. Even during the bear market of 2020, when oil prices turned negative, ENB managed a small 3% dividend hike. So if the future resembles the recent past, this stock could give investors a double-digit return on cost in the near term.

However, Enbridge’s dividend is not without its problems. The payout ratio, based on earnings, is 122%, suggesting that the company pays out more dividends than it earns. On the other hand, Enbridge touts its “distributable cash flow” payout ratio as being more indicative of its ability to pay dividends. This payout ratio is only 69% – which is high, but not unsustainable. The question is whether Enbridge’s “distributable cash flow” is trustworthy and whether the company can grow it over time. In this article, I will argue that Enbridge will likely be able to continue paying its dividend, but has some financial downsides that could hurt its total return.

What is distributable cash flow?

To assess whether ENB’s dividend is sustainable, we need to look at the company’s chosen payout ratio. The dividend is not sustainable on an earnings basis, so we need to explore the metric it uses as an alternative. Sometimes earnings are influenced by non-cash factors that do not reflect the ability to pay dividends. So maybe ENB’s cash flow approach is valid.

According to Enbridge, Distributable Cash Flow (“DCF”) consists of the following:

  • Operating cash.

  • Change in net operating assets.

  • Receipts not recognized as revenue.

  • Dividend payments that are not included in the CFO.

  • Certain distributions received.

Basically, the DCF is a CFO only with some investing cash flows added and financing cash flows subtracted. Other than the change in operating assets, these adjustments to CFO seem reasonable. Positive investing cash flows add to your cash flow, preferred dividend payments subtract. So Enbridge is probably correct that DCF is a better indicator of dividend-paying power than CFO. Also, in Enbridge’s reporting, DCF is not always greater than CFO, so it’s not a “crazy” non-GAAP measure used to mislead investors.

Enbridge: distributable cash flow

Enbridge: distributable cash flow (Enbridge)

Nature of business

As we’ve seen, Enbridge’s DCF measure is probably a decent measure of the ability to pay dividends. So it seems reasonable to trust its use. However, like any other business, we need to know Enbridge’s growth prospects to know if this “DCF” can grow over time. So you have to look at the nature of the business.

Enbridge is a pipeline company that also operates as a natural gas utility. It supplies natural gas to Ontario and exports crude oil to the United States. It has a favorable competitive position. It has the second longest crude oil pipeline network in the world, stretching 20,971 miles. This gives it the advantage of being able to reach various destinations that other pipelines cannot reach. In addition, Enbridge has the financial advantage of long-term contracts. Most of ENB’s contracts last for several years, during which ENB’s customers reserve part of the pipeline network for their use. Because customers “rent” pipeline space rather than giving ENB a sales cut, ENB makes money even when volume is low. According to writer Matthew DiLallo, only 4% of Enbridge’s EBIT is exposed to short-term volume fluctuations, the rest comes from long-term tolls, which are essentially a kind of “annuity”.

This means that the bullish or bearish trend of the oil market is of little concern to ENB. Once he has entered into a contract with a client, he becomes like a landlord with a lease. His contracts usually last several years. Last year, he tried to increase the length of his contract to a minimum of eight years. Unfortunately for shareholders, Canadian regulators shot that one down, but ENB’s contracts are still reliable enough to produce less earnings volatility than the average energy company.

The long-term outlook for ENB’s business is therefore quite good. As long as people ship oil by pipeline, ENB will have a volume of business. The competitive landscape also favors Enbridge. Many projects by Enbridge’s competitors are rejected by regulators, while the company’s own projects thwart regulatory challenges. For instance, TC Energy (TRP) saw its Keystone XL project closed in 2021, while Enbridge defeated Michigan’s attempt to close Line 5. Enbridge therefore faces less competition over the next 10 years than it seemed. a few years ago.

finance

Having reviewed Enbridge’s business outlook, we can now examine its financial statements. Enbridge is a very profitable company with decent growth, but it has good debt. Over time, the debt could hurt ENB’s ability to continue increasing its already high dividend, so it’s worth considering.

First, the earnings and cash flow numbers.

According to Seeking Alpha Quant, ENB released the following metrics over the 12 month period:

  • Turnover: 40 billion dollars.

  • EBIT: $6.3 billion.

  • Net income: $4.98 billion.

  • Operating cash flow: $7.7 billion.

  • Free cash flow: -607 billion dollars.

Free cash flow aside, these are all solid numbers. In addition, they are experiencing significant growth. Over the past 5-year period, the CAGR growth rates in the above metrics were:

  • Turnover: 6.27%.

  • EBIT: 16.5%.

  • Net income: 20%.

  • Operating cash flow: 7.7%.

  • Free cash flow: N/A

As you can see, growth has been solid outside of free cash flow, which is currently negative. ENB’s free cash flow is currently being negatively impacted by heavy infrastructure spending. The company is working on Line 3 and Line 5 upgrades, and these are capital-intensive projects. Shareholders are paying for all of these capital expenditures right now. However, the projects could bring future benefits. For example, replacing Line 3 will increase the diameter of the pipe by 2 inches, allowing more oil to be transported. Increasing pipeline capacity could increase revenue because the width of the pipe determines how much oil can enter it. So, while ENB expenditures have a negative impact on the FCF, the path to future benefits from these expenditures is relatively straightforward.

Having looked at ENB’s earnings and cash flow, we can now turn to its balance sheet. In its last quarter, ENB had the following balance sheet metrics:

  • $135 billion in assets.

  • $84 billion in liabilities.

  • $8.2 billion in current assets

  • $12.1 billion in current liabilities.

  • $56 billion in long-term debt.

  • $51 billion in equity.

On a positive note, assets greatly exceed liabilities, leaving a decent book value. Less flattering, there is more debt than equity (a leverage ratio of 1.1), and not a lot of cash (a current ratio of 0.67). Moreover, although ENB’s assets greatly exceed its liabilities, its debt is quite high. The debt to operating cash ratio is 7.3. A debt of $56 billion financed at 5% interest absorbs $2.8 billion in profits. ENB’s actual interest expense during the TTM period was approximately $2 billion, so interest is already affecting net income somewhat.

All of this has an impact on the evaluation of ENB. At today’s prices, ENB stock is relatively cheap compared to the S&P 500. It trades at 19.5 times earnings, 2.13 times sales and 11.3 times cash flow. operation. These are not low multiples for energy stocks, but they are low relative to market-weighted averages. You might think of Enbridge as some sort of value play, but the weak balance sheet hurts that idea somewhat. Enbridge’s debt is already taking huge chunks out of its net income, what if it has to borrow another $10 billion to complete one of its many infrastructure upgrades? Interest rates are rising these days, so the impact could be quite significant.

Risks and Challenges

As I have shown in this article, Enbridge is a dividend-paying stock whose payout is reasonably well covered by cash flow. Its huge interest charges will likely dampen total returns, but you can count on it as a pure income game. That said, even this part of my thesis faces some risks and challenges, including:

  • Rise in interest rates. Central banks are raising interest rates this year, and the hikes are expected to continue. It’s bad for Enbridge because it’s hugely indebted. Unlike E&P, Enbridge is not generating “windfall” earnings this year that can be used to pay down debt. Instead, it makes massive capital expenditures. If he has to borrow more to complete the work on Lines 3 and 5, his interest costs will increase. This could have a negative impact on its ability to continue to increase its dividend.

  • Regulatory barriers. Enbridge faces considerable pressure from regulators, including environmentally conscious politicians in the United States and pro-energy regulators in Canada. In the United States, ENB has governors trying to close Line 5 for environmental reasons. In Canada, regulators are banning longer-term contracts for fear they will hurt E&Ps. Pressure from both sides of the island is quite strong here, and it could hamper Enbridge’s efforts to further secure the recurring revenue that investors expect from it.

Taking these risk factors into consideration, I rate Enbridge as “Successful”. Its dividend as it stands today is sustainable, but continued increases could cause problems in the future. The amount of debt this company carries on its balance sheet is staggering. This is not a threat to the dividend in the short term, but it could complicate things in the long term.

About Myra R.

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