Enbridge Inc (NYSE:ENB) is a Canadian oil and gas midstream giant that sports an impressive 4.6% yield -- well more than twice what the broader market is offering investors today. It has big plans, too, calling for compound annualized dividend growth of as much as 12% over the next few years. But there's a fly in the ointment that you'll want to know about before you step in here, which is why the experts are watching how the company's leverage and dividend growth play against each other.
In this industry, dividend cuts can happen
Enbridge largely owns midstream oil and gas assets, though it has some electricity investments, as well. Generally speaking, pipeline owners have reliable income streams driven by the industry's toll-taker business model. But things don't always work out as planned. Take, for example, midstream giant Kinder Morgan's (NYSE:KMI) 75% dividend cut in 2016.
In the months leading up to the cut, Kinder was talking about a 2016 dividend increase and highlighting its commitment to returning value to shareholders via regular dividend hikes. However, heightened leverage left the company in a quandary: how to fund growth spending and support the dividend at the same time. The dividend got sacrificed to support spending. It was probably the right long-term move, but it certainly wasn't a positive outcome for dividend investors.
A problem at Enbridge?
Enbridge's big plans include distribution growth of as much as 12% a year through 2024. Backing that up is roughly CA$31 billion ($25 billion) in growth projects. It's also counting on synergies from the recently completed Spectra Energy acquisition to help, as well. That's the good news. The bad news is that Enbridge has also made some other notable moves.
One was to take Midcoast Energy Partners private, including buying out affiliated Enbridge Energy Partners, L.P.'s (NYSE:EEP) stake in Midcoast. Midcoast had been struggling, with Enbridge Energy Partners providing it with cash so it could cover its distribution. Enbridge basically just took sole responsibility for a struggling midstream business. That's good news for Enbridge Energy Partners, but less so for parent Enbridge, which now has to get that business back on track.
Along with this move, and more worrying for the dividend, Enbridge also undertook a review of Enbridge Energy Partners' business. When all was said and done, the final decision was to cut Enbridge Energy Partners' distribution by 40%. That will help to shore up Enbridge Energy Partners' finances, since it won't have to distribute as much to investors. But it also means that parent Enbridge will have less cash coming in from the partnership via the now lowered distribution.
With that as a background, take a look at the chart above: Enbridge's debt to EBITDA ratio has been tracking eerily close to that of Kinder Morgan. That leverage ratio is well above the levels of Magellan Midstream Partners, one of the more conservative names in the midstream space. Enbridge's Leverage is an issue you need to watch closely, but it's particularly concerning when you consider the company's spending plans and the 40% distribution cut at Enbridge Energy Partners.
Watch leverage and dividend growth
There's no indication that Enbridge won't be able to support its capital plans and dividend growth at this point. But there was no particular indication of the risk of a dividend cut at Kinder, either -- other than elevated levels of leverage. This is why you want to keep an eye on the interplay between Enbridge's leverage and its dividend plans.
Enbridge is effectively trying to balance high leverage and high dividend growth. If something goes wrong with its investment plans (higher than expected project costs or a capital project falling through, for example), it may not have the flexibility to adjust. And, if push comes to shove, I would expect Enbridge to follow Kinder Morgan's path of choosing to fund its growth projects over supporting the dividend. It's the right long-term move, but it would leave dividend investors hurting.
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Enbridge and Kinder Morgan. The Motley Fool recommends Magellan Midstream Partners. The Motley Fool has a disclosure policy.