Canadian based Enbridge Inc. (NYSE:ENB) is offering investors a 6.1% yield. U.S. midstream player Magellan Midstream Partners, L.P. (NYSE:MMP) provides a distribution yield of 6.6%. Before you decide to go with the higher-yielding midstream name, here, you should dig in a little more. There are some big differences between these two key industry players that you need to understand.
More than just yield
Enbridge, with a $75 billion market cap, is one of the largest energy companies in North America. Although it hails from Canada, its diversified collection of assets spans the continent. It also owns a collection of power-generation assets, pushing its reach beyond the typical midstream company domain and further increasing its diversification. It is -- and this is perhaps understating it a little bit -- an industry Goliath.
Magellan weighs in at a far more modest $13 billion market cap. It is a sizable entity, but it certainly doesn't have the scale and reach of Enbridge. That's not a bad thing, as it can sustain growth with smaller capital projects (it takes material investments to move the needle at Enbridge). Magellan is also strictly focused on the midstream space. And it's important to note that Magellan is a master limited partnership, which comes with notable tax considerations and makes it an inappropriate option for tax-advantaged retirement accounts.
So, there are important scale, reach, and structure differences here that need to taken into consideration before investing. But there's another big-picture topic that needs to be carefully examined, too.
Taking some risks
Enbridge and Magellan have both been around for a long time. And they both have impressive histories of rewarding income investors well. Enbridge, for example, has increased its dividend for 22 consecutive years. And while Magellan's 18 years of annual hikes falls short of that mark, it has instituted an increase every quarter since going public in 2001. The two basically stand toe to toe on this one. (Note that Enbridge pays in Canadian dollars, so the amount U.S. investors receive will vary with exchange rates.)
However, there's a key difference in how these two companies have gone about achieving these results. Magellan is among the most conservative midstream players around, focusing on slow and steady growth over time. It is a tortoise that makes sure to keep risk as low as possible. For example, its debt to EBITDA ratio is around 2.5 times, near the low end of the industry. In fact, it recently rejiggered its capital raising plans with the goal of ensuring that distribution coverage remained at 1.2 times to reassure investors about the safety of its distribution. Magellan is a good option for risk-averse investors.
Enbridge, on the other hand, has taken a slightly more aggressive approach, using leverage to a greater degree. The company's debt-to-EBITDA ratio is currently around 6.7 times, near the high end of the industry. While that ratio has been on the downswing since Enbridge bought a large midstream peer and simplified its business (selling assets and buying in a number of its subsidiary public entities), it has long made greater use of leverage than Magellan.
To be fair, Enbridge has done a decent job of managing its leverage over time. And it has notably avoided the disbursement blow-ups that have hit midstream peers, such as Kinder Morgan, Buckeye Partners, and Plains All American, which attempted similar simplification moves, made aggressive use of leverage, or both. The proof is in the continued upward march on its dividend, which has grown at an annualized rate of 12.4% over the past decade. However, Magellan is no slouch, here; its distribution increased at an annualized rate of 10.9% over the same span despite its more conservative use of leverage.
But the past is the past. Going forward, Magellan is projecting distribution growth in the mid single-digits. Enbridge is projecting dividend growth of around 10% through 2020. That helps explain at least a portion of the yield difference, with investors giving a premium valuation to Enbridge because of its higher dividend growth prospects. If you are focused on dividend growth, Enbridge has the clear edge.
What are you looking to achieve?
At the end of the day, both Enbridge and Magellan have proven to be well-run midstream players and would each be a fine investment option. However, there is a fundamental difference in how they go about their operations. One of the biggest issues to look at is their use of leverage. If you are a conservative investor looking to maximize current income, then Magellan is likely to be the better call. For investors willing to take on a little more risk in exchange for larger dividend increases, then Enbridge could be the right fit. Neither is a bad choice, but they are definitely not interchangeable options.