Enbridge Inc. (ENB) is a Canadian energy transportation company. It has operations not only throughout Canada, but also in the eastern and mid-west USA. It transports energy resources via pipelines, trucks, trains, and boats. The company was founded in 1949, and it is headquartered in Calgary, Alberta, Canada.
Enbridge’s Dividend Record
Enbridge is a rare high-yield, fast-growth dividend company. Its 5- year dividend growth rate of nearly 11% per year is very fast for a company that yields over 6% to begin with.
I consider this to be an excellent growth record.
At June’s earnings conference call, executives reiterated their target of a 10%-ish dividend hike for 2020.
Final decision on that will come toward the end of the year.
I would like to see a better dividend safety score from Simply Safe Dividends, which gives Enbridge a 57 (out of 100 points) in dividend safety.
Pipeline companies and other capital-intensive industries tend to get lower scores. In its discussion of ENB’s dividend safety, Simply Safe Dividends points out the following positives and negatives that lead to its average score:
• Relatively high payout ratios, although not crossing into unsafe territory
• Decent debt levels
• Increased payout each year throughout Great Recession
• Size and scope of company’s operations
Enbridge’s Business Model and Company Quality
Enbridge transports and distributes oil, natural gas, and natural gas liquids over a wide swath of North America, connecting supply basins with key demand centers. It also operates a gas utility business.
Most pipeline companies are Master Limited Partnerships (MLPs), but at the end of 2018, Enbridge completed a legal and structural transformation from being an MLP to becoming a corporation.
In the process, Enbridge became more streamlined, and all of its core pipeline assets were rolled up into a single publicly-traded entity.
Enbridge has been moving its business in the direction of a pure pipeline and utility model. The company transports:
• 25% of North America’s crude oil
• 20% of the natural gas consumed in the USA
• 65% of USA-bound Canadian crude oil exports
Enbridge owns and operates the world’s longest crude oils and liquids transportation system. This map shows Enbridge’s vast network of pipelines, storage facilities, and processing plants.
[Source of above map and remaining displays in this section]
Enbridge operates the world’s longest and most complex crude oil and liquids transportation system. Its pipelines are well integrated, rather than being geographically scattered. Its regional oil sands pipelines and expansion projects place Enbridge in good position to benefit from growing oil sands crude supply.
Government regulations on Enbridge’s major pipeline assets help insure stable cash flows. They also serve as a barrier to entry for competitors.
Enbridge also owns the largest gas utility in North America. It delivers energy to about 3.7 million homes and businesses in Ontario, including the Toronto and Ottawa metropolitan areas.
The following slide shows Enbridge’s three core businesses and how much they contribute to the whole company.
Enbridge bills itself as the largest, low-risk diversified energy infrastructure company in North America. This is how they summarize their investment proposition.
Pipeline companies’ profitability is not correlated directly to commodity prices, because the need to ship products tends to continue no matter what the underlying price of the commodity is. However, there can be an indirect effect as demand for product is somewhat cyclically tied to its price.
That said, this display shows how Enbridge’s profits have risen even during challenging economic years, especially during the collapse of crude oil prices in 2015-16.
The “EBITDA” metric used in the above chart means earnings before interest, taxes, depreciation, and amortization. It is a metric that has particular relevance to capital-intensive businesses like pipeline companies.
Enbridge estimates that 98% of its EBITDA is not sensitive to commodity prices. Here is how the company views its business as low-risk:
Looking ahead, Enbridge has about $19B worth of expansion, extension, and maintenance projects planned over the next few years. The company refers to these as “secured, low-risk capital projects.” Of course, their success cannot be guaranteed, but they are expected to extend Enbridge’s integrated pipeline system and form most of the basis of its growth over the next couple of years. The company estimates that it can self-fund $5-6 B of annual organic growth opportunities.
Beyond its core pipeline business, Enbridge also owns and operates a gas utility business in Ontario, Canada. It is Canada’s largest natural gas distribution company, and it benefits from regulated returns. As Ontario’s population grows, Enbridge sees opportunities to add 50-70 new communities to its gas distribution network over the coming years.
Overall, Enbridge forecasts 5-7% business expansion annually.
Here is my summary of Enbridge’s business model and quality.
I should note that Morningstar rates Enbridge as one of its “Best Ideas.” Its wide-moat rating is based largely on Enbridge’s economies of scale and the integrated (rather than scattered) nature of its pipeline network.
Also to be noted: While Value Line gives Enbridge a safety rating of 3 on a 5-point scale, Enbridge’s 5-year beta (a measure of stock price volatility) is just 0.59, meaning that its price has been much less volatile than the market’s volatility (as measured by the S&P 500).
Enbridge’s Financials
Value Line gives Enbridge its fourth-highest Financial Strength grade: B+ on a scale with nine levels. The company has held that grade since 2011.
Let’s look at key financial categories and see if we agree.
Return on Equity (ROE) is a standard measure of financial efficiency. ROE is the ratio of profits to shareholders’ equity.
The average ROE for all Dividend Champions, Challengers, and Contenders is 12%. Champions by themselves are at 10%. The following chart shows Enbridge’s ROE 2009-2018.
[Source of all yellow-bar charts in this section: Simply Safe Dividends]
Enbridge’s ROE is below average. Over the past 12 months, it has run at 7%. A relatively low ROE is not untypical of pipeline companies.
Debt-to-Capital (D/C) ratio measures how much the company depends on borrowed money.
Companies finance their operations through a mixture of debt and equity (shares issued to the open market) as well as their own cash flows.
A typical D/C ratio for a large, healthy company is 50%.
The normal use of D/C is to gauge risk, because it helps determine how strong the balance sheet is. All else being equal, stocks with high D/C ratios are generally riskier than those with low D/C ratios.
For such a capital-intensive business, Enbridge does not carry a lot of debt. And its debt level has been steadily going down for several years, as it has been deleveraging its capital structure.
The relatively low level of debt helps explain Enbridge’s low ROE, because high debt levels drive ROE up. The slide below shows the impact of ENB’s deleveraging program.
Operating margin is one of my favorite financial metrics. It measures profitability: What percentage of revenue is turned into profit after subtracting cost of goods sold and operating expenses.
Per recent research, typical operating margins for S&P 500 companies have been in the 11-12% range.
Enbridge’s operating margin has been rising in recent years. By my way of thinking, it has risen from an OK range into a good range. Simply Safe Dividends reports that Enbridge’s operating margin has risen further to 17% over the past 12 months.
Earnings per Share (EPS) is the company’s officially reported profits per share. We want to see if a company has had years when it officially lost money, or if its earnings are steadily increasing, declining, or flat.
Enbridge’s EPS have been variable. Despite the theoretical independence of its business model from oil prices, we see that in 2015, its earnings took a hit when the price of oil crashed. Earnngs rose in only three of the nine years charted, although there were positve earnings in all years except 2015.
CFRA’s forward estimates for EPS growth are in the 5%-10% range over the next two years. The company itself has guided to 6% earnings growth for this year.
Free Cash Flow (FCF) is the money left over after a company pays its operating expenses and capital expenditures. Whereas EPS is subject to GAAP accounting rules, cash flow is a more direct measure of money flowing through the company. It’s the money a company has available for dividends, stock buybacks, and debt repayment.
Excess FCF allows a company to pursue investment opportunities, make acquisitions, repurchase shares, and pay/increase dividends.
Free cash flow is often low or even negative for many pipelines, because so much of their cash flow goes to the capital expenses necessary to maintain and expand their businesses. We see that with Enbridge.
Enbridge uses a related measure, called Distributable Cash Flow (DCF), which gives a more relevant picture of its dividend capacity. This slide is from Enbridge’s most recent earnings presentation in June, 2019.
Enbridge’s DCF picture is stable., and the company has been forecasting a 5-7% growth rate for coming years.
Share Count Trend shows whether the company’s outstanding shares are increasing, decreasing, or remaining flat.
I like declining share counts, because the annual dividend pool is spread across fewer shares each year. That makes it easier for a company to maintain and increase its dividend. By buying back its own shares, the company is essentially investing in itself and expanding each remaining share into a larger piece of the pie.
Enbridge’s share count has risen dramatically over the past couple of years. This helps explain why the company has been able to hold its debt level down while engaging in so many major capital projects: It is funding them by issuing new shares rather than taking on more debt.
Here is a summary of the items above:
Taking everything into account, I think that Value Line’s B+ financial rating is about right for Enbridge. Capital-intensive businesses, by their nature, do not generally score well on standard metrics that work well for other companies.
Value Line’s scale has a top level of A++. On a more common scale of A-F, I would give Enbridge a C+.
Enbridge’s Stock Valuation
I use four different approaches, then average them out.
Step 1: FASTGraphs Basic. The first step is to compare the stock’s current price to FASTGraphs’ basic estimate of its fair value.
The basic valuation estimate uses a price-to-earnings (P/E) ratio of 15, which is the historical long-term P/E of the stock market, to create a basic fair- value reference line.
In the following chart, the fair-value reference line is orange, the black line is Enbridge’s actual price, and I circled the stock’s current P/E ratio.
Since the black price line is above the orange fair-value reference line, Enbridge is overvalued by this first method.
To calculate the degree of overvaluation, we make a ratio out of the P/Es.
Calculating Valuation Ratio from FASTGraphs
Actual P/E ratio / Reference P/E ratio
17.9 / 15 = 1.19
That suggests that Enbridge is overvalued by 19%.
We calculate the stock’s fair price by dividing the actual price by the valuation ratio. We get $35 / 1.19 = $29 for a fair price.
Remember, valuation is an estimate or assessment, not a physical trait like length or width. We are making a judgement. Different models will come up with different results. That’s why I average four approaches.
Step 2: FASTGraphs Normalized. The second valuation step is to compare Enbridge’s current P/E to its own long-term average P/E.
This step paints a different picture. Here the price line is below the fair-value line, suggesting that Enbridge is undervalued.
ENB’s 5-year average P/E is 24.1 (circled). The blue fair-price reference line is drawn using that P/E.
Our valuation ratio is 17.9 / 24.1 = 0.74. The fair price calculation is $35 / 0.74 = $47.
Step 3: Morningstar Star Rating. Morningstar takes a different approach to valuation. They ignore P/E ratios and instead use a discounted cash flow (DCF) model for valuation. Many investors consider DCF to be the best method of assessing stock valuations.
In a nutshell, the DCF model is based on the idea that a company is worth all of its future cash flows, discounted back to the present to reflect the time value of money.
Obviously, no one actually knows a company’s future cash flows. Estimates must be used. My experience with Morningstar is that they have a careful, comprehensive, and conservative process.
Morningstar gives Enbridge 4 out of 5 stars, meaning that they consider the company to be undervalued. Here is a historical graph of their fair value estimates (black line) compared to the stock’s price (dotted).
Morningstar’s approach results in a valuation ratio of 0.75, almost identical to the one we got in our second step. They calculate a fair price of $47.
Step 4: Current Yield vs. Historical Yield. My last step is to compare the stock’s current yield to its historical yield. This way of estimating fair value is based on the idea that if a stock’s yield is higher than usual, it may indicate that its price is undervalued.
This chart shows Enbridge’s current yield (green dot) compared to its 5-year average yield.
[Source: Simply Safe Dividends]
Enbridge’s 5-year average yield is 4.5%, while its current yield is 6.4%. When the current yield is higher than the historical average, that suggests that the stock is undervalued.
As with the other methods, we can make a valuation ratio out of these numbers.
Calculating Valuation Ratio from Yield Comparison
Historical yield / Current yield
4.5% / 6.4% = 0.70
That suggests undervaluation of 30%. However, when I use this method, I cut off the estimates at 20%, because I don’t want to stray too far based on relative yield.
At 20%, we get a fair price of $35 / 0.80 = $44.
Valuation Summary:
The bottom line combining my four models is that Enbridge is 17% undervalued, with a fair price of $42. If we threw out Method #1 as an outlier, we would get an even more dramatic undervaluation of 24% and a fair price of $46. To be conservative, I keep the outlier, because in this case it moderates the result.
Miscellaneous Factors
Beta
Beta measures a stock’s price volatility relative to the S&P 500. I like to own stocks with low volatility for 2 reasons:
• They present fewer occasions to react emotionally to rapid price changes like price drops that can induce a sense of fear.
• There is industry research that suggests that low-volatility stocks outperform the market over long time periods.
Enbridge’s 5-year beta is 0.59, which means its volatility has been, on average, 41% less than the market’s. This is a positive factor.
Analyst’s Recommendations
In their most recent report on Enbridge, CFRA gathered the recommendations of 23 analysts covering the stock. Their average recommendation is 3.8 on a 5-point scale, where 3 = hold and 4 = buy. So the average recommendation is just short of buy.
This is a slightly positive factor.
What’s the Bottom Line on Enbridge?
Enbridge’s positives:
• Excelllent dividend yield (6.4%) combined with fast dividend growth rate (5-year average of 10.9% per year).
• Stated commitment to dividend increases, backed up by 23-year streak of annual raises, including a 7.1% raise earlier this year.
• Owns and operated world’s longest crude oil and liquids transportation system across North America. System is well integrated. Many of its revenues are regulated and dependable under long-term contracts.
• Also operates large regulated natural gas system in Ontario.
• Investment-grade credit rating from S&P, Wide Moat rating from Morningstar, and B+ business quality rating from me. Also carries “Best Ideas” designation from Morningstar.
• Financials are decent for a pipeline company. Relatively low debt levels as Enbridge has moved toward a self-funding business model. The other side of that coin is that Enbridge’s share count has been rising for several years.
• Low 5-year beta of 0.59.
• Shares are 17% undervalued.
Enbridge’s negatives:
• Average dividend safety rating from Simply Safe Dividends (57/100).
• Business, while insulated from direct impacts of natural resource price changes, is still subject to cyclical changes in demand for oil and gas transportation.
• Rising share count for several years, which is the flip side of operating with moderate debt levels in capital-intensive business.
In my opinion, Enbridge is a very attractive dividend-growth stock opportunity, especially given its 17% undervaluation, high yield, and healthy dividend growth trajectory and outlook.
Here are other recent discussions of ENB on Daily Trade Alert:
• Undervalued Dividend Growth Stock of the Week (Jason Fieber, August, 2019)
• This Dividend Growth Stock Appears 19% Undervalued (Dave Van Knapp, August, 2019)
• Jason Fieber’s FIRE Fund – May 2018 Update (purchased 5 shares of ENB for portfolio)
• Top 10 Stocks for 2018 (Jason Fieber, January, 2018)
Remember that this is not a recommendation to buy, hold, or sell Enbridge. Always do your own due diligence. Think not only about the company’s quality, dividend outlook, and business prospects, but also about how and whether it fits your personal financial goals.
— Dave Van Knapp
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