After acquiring U.S. natural gas pipeline rival Spectra Energy last year, Enbridge (ENB 2.74%) vaulted to the top of the class as North America's largest energy infrastructure company. Even better, by adding Spectra's large growth pipeline, Enbridge has the expansion projects in development to fuel 10%-12% compound annual dividend growth all the way through 2024, according to its estimates. That makes it a dream stock for income seekers.
That said, while it would appear that Enbridge's best days lie ahead, bearish investors see potential problems that could derail the company's growth ambitions. Here's a closer look at two things that are causing some investors to be a bit skeptical of that forecast.
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There's still plenty of risk in the backlog
When Enbridge announced the acquisition of Spectra Energy, it noted that the combined entity had secured an industry-leading 26 billion Canadian dollars' ($20 billion) worth of near-term capital projects, which would fuel 12% to 14% compound annual growth in available cash flow from operations through 2019. Furthermore, the company had another CA$48 billion ($37 billion) projects in development, which gave it the confidence to extend its double-digit dividend growth projection all the way through 2024. In fact, since that time Enbridge has moved CA$3.6 billion ($2.8 billion) of its development projects into its near-term backlog, which increases its earnings growth visibility into 2020.
That said, bears would argue that there's ample risk that Enbridge could face problems completing many of these projects, especially the largest project in its backlog, which is the CA$7.5 billion ($5.8 billion) Line 3 Replacement that should enter service in 2019. While the company has received most of the regulatory approvals it needs, it faces local opposition to the project. Because of that, future legal challenges could lead to a lengthy delay in the project's in-service date and might result in its costs rising.
That's what happened to Energy Transfer Partners' (ETP) Dakota Access Pipeline, which came under intense opposition last year, causing a significant delay in the completion of construction. Furthermore, Energy Transfer Partners has run into issues even after finishing the project and might need to stop the flow of oil on the pipeline and undertake a new environmental review if it loses its latest legal battle.
In addition to the potential delay of a project that Enbridge is banking on to fuel near-term dividend growth, there's also the risk that it might not move forward with as many development projects as it anticipates. If oil prices remain low, it's possible that producers won't need as much capacity as it has in development. Meanwhile, there is a risk that it could lose out on expansion opportunities to rival gas pipeline projects.
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Leverage is quite high, which could become a problem if credit tightens
Another potential issue that could derail Enbridge's forecast is securing the financing for its expansion opportunities. Because the pipeline giant expects to pay out between 50% to 60% of future cash flow via dividends, it won't generate anywhere near enough internal cash flow to fund all its future expansions. In fact, the company only expects to generate CA$14 billion ($10.8 billion) of internal cash flow after dividends through 2019, which would only cover half its capital requirements. Furthermore, the company has another CA$10 billion ($7.7 billion) of debt maturing over that time frame that it needs to address.
That debt is a bit of a concern because the company had an elevated leverage ratio of 6.2 times at the end of last year. As a result, the company only expects to issue enough debt to refinance its upcoming maturities, which still leaves it with a gaping hole to fill over the next few years. While the company has several options to bridge the gap, including asset sales, equity issuances, hybrid securities, and other alternatives, it might have a problem raising that capital at an attractive rate if market conditions deteriorate -- especially while its leverage remains elevated.
That's exactly what happened to Energy Transfer Partners last year. Because of the delays on the Dakota Access Pipeline, the company couldn't tap into the construction financing it secured to support the project, nor close the sale of a minority stake in the pipeline to a joint venture. Because of that, it had to complete an equity offering earlier this year even though its units had fallen nearly 25% from the 52-week high. However, with an upcoming debt maturity, the company needed the cash since it couldn't fully refinance that debt due to its elevated leverage ratio, which was more than 6.0 times debt-to-earnings before interest, taxes, depreciation, and amortization.
Investor takeaway
Enbridge believes it will be able to deliver double-digit dividend growth to investors through at least 2024, thanks to a boatload of high-return capital projects in its backlog. Bearish investors, on the other hand, remain skeptical that the company can pull it off, especially because of the potential for a legal battle surrounding the largest project in its pipeline and the large gap between its current capital resources and capital expenditures needs, which are issues that plagued Energy Transfer Partners in recent years.
That said, Enbridge remains well aware of these risks, which is why it plans to maintain enough liquidity to cover a year of capex and minimize its use of debt over the next few years. Because of these factors, I'm quite confident that Enbridge can achieve its ambitious growth goals even if it inevitably runs into issues along the way.
