Energy infrastructure giant Enbridge (NYSE:ENB) is coming off a down year, with its shares dipping 7% even though the market was red-hot. While the energy sector underperformed last year, Enbridge's slump was mainly because its available cash flow from operations (ACFFO) per share was on pace to end the year 8% below 2016's level -- but that's also because the company issued a boatload of new shares to buy Spectra Energy as well as finance expansion projects.
Those growth initiatives should start paying off in 2018, with Enbridge expecting ACFFO per share to rebound 15% this year. Consequently, its stock is dirt cheap right now, which is one of the many reasons Enbridge looks like a compelling buy for 2018.
A great dividend with more to come
One of the attractions for investors is Enbridge's dividend, which at 4.7%, is well above average. However, what's even more critical is its safety, which is where Enbridge's payout shines. After all, the company generates very predictable cash flow since 96% of its earnings come from fee-based contracts or similar rate structures. Meanwhile, it only pays out about 65% of its cash in support of the dividend, which is a conservative level for a pipeline company. For comparison's sake, rival Targa Resources (NYSE:TRGP) only gets about 66% of its earnings from stable sources and yet pays out just about everything that comes in to support its 7.1% dividend yield. That puts Targa at high risk of having to reduce its payout if cash flow dives as a result of plunging commodity prices.
That said, as good as Enbridge's dividend is right now, it's only expected to get better in the coming years. The company completed 14 billion Canadian dollars ($11.4 billion) of growth projects last year and had another CA$22 billion ($17.8 billion) underway. These expansions should drive its ACFFO up 15% this year and by a 10% compound annual growth rate through 2020. That will enable an increase in its dividend at that same pace. For perspective, that matches the growth rate of fellow Canadian pipeline rival TransCanada (NYSE:TRP), though with a 4.2% payout, investors can collect more income from Enbridge over that time frame.
A steadily growing income stream for an excellent price
That said, what sets Enbridge apart from most other pipeline rivals is its valuation. With the stock currently trading at $39.50 apiece and given the expectation that the company can generate between CA$4.15 to CA$4.45 ($3.37 to $3.61) per share in ACFFO this year, it implies a valuation of 11.3 times cash flow. That makes it one of the cheapest pipeline stocks in the sector considering that the average one trades at about 14.9 times cash flow. In fact, despite much weaker financials, Targa Resources trades at 14 times cash flow while TransCanada sells for around 15 times even though it has similar metrics and growth prospects as Enbridge.
That valuation discount doesn't make any sense. While the company does have an elevated leverage ratio of more than 5.0 times at the moment, that's because it has been financing a massive expansion project backlog. As those projects enter service, it should push that metric to a more comfortable level of less than 4.0 times by 2020. In fact, the company is planning to sell some non-core assets to help it get leverage down quicker.
A good buy for 2018 and beyond
After a down year in 2017, Enbridge is on pace to bounce back this year as recently completed expansion projects should bolster earnings. That catalyst could drive the stock much higher in 2018 and help push its valuation closer to the peer group average. That said, in addition to that bounce-back potential, Enbridge is on track to grow earnings and its already generous dividend by double digits over the next few years, which could potentially give it the fuel to deliver market-beating returns over that time frame. It's that combination of near-term upside and long-term potential for such an excellent price that makes Enbridge a stock to consider buying this year.