Canadian-based Enbridge (ENB 2.40%) offers investors a 6% yield, while Plains All American Pipeline (PAA 3.44%) has a 7.5% yield. Before you simply jump at the higher yield here, though, you need to do a little more homework. These two midstream companies are very different. In the end, one does look like a better option than the other. But here's the thing: While the dividend is a key consideration, the yield is actually less important than you might think.
1. Size and scale
Plains is a midstream focused master limited partnership. It owns a diverse collection of pipelines, along with storage, processing, and transportation assets that help to move oil and natural gas from where they get drilled to where they end up being used. It has a $13.5 billion market cap, so it is hardly small. That said, it isn't exactly an industry giant, either.
Enbridge's market cap is $82 billion. It is easily the largest energy companies in North America. Midstream assets are the core of its portfolio, with about half of its business (53% of EBITDA) tied to liquids pipelines. That's roughly similar to what Plains does. The rest is largely tied to natural gas distribution and storage (42%), with the company operating a sizable natural gas utility business. A small portion of its operations (5% or so) is in the renewable power space. Basically, Enbridge is much bigger and much more diversified.
2. A little dividend history
Plains' current yield is higher than what you'll get from Enbridge, but that's not the entire story. Plains cut its distribution in 2016 and then again in 2017. The total reduction was a painful 57%. The prime reason for the reduction was an elevated level of leverage at a point when the midstream sector was facing headwinds. Management thought one cut would be enough to get it back on track, but that turned out to be overly optimistic. A persistently weak operating environment necessitated a deeper retrench. In 2019 the dividend started to head higher again, showing that progress is finally being made. But the duo of cuts should weigh heavily on dividend-focused investors looking to live off of the income they generate from their portfolios. That said, the current goal is distribution coverage of around 1.3 times, which is pretty good for a midstream company. Plains is definitely trying to be more conservative as it moves forward.
Enbridge, on the other hand, has increased its dividend annually for 25 consecutive years. The average annualized rate of growth over the past three-, five-, and 10-year periods have each been a touch over 10%. That's an impressive rate of growth that's more than three times the historical growth rate of inflation. Although the most recent increase was "only" in the high-single-digit range, there's no question that Enbridge's dividend history is better than Plains'. The long-term goal is to payout roughly 65% of distributable cash flow, which is reasonable and leaves ample room to support the dividend through difficult times.
3. The balance sheet
Although leverage got Plains into trouble, it's important to give credit where credit is due here. The management team has trimmed the financial debt to EBITDA ratio down from over 6 times just a few years ago to around 2.3 times today. That's near the low end of the midstream peer group. Although the partnership still has much to do to mend the trust issue associated with the pair of distribution cuts, it has made good on the promise to create a sounder financial foundation.
Enbridge's financial debt to EBITDA ratio is much higher at around 4.8 times. That's higher, but not out of line with the midstream sector. But it's important to note that Enbridge isn't just a midstream company -- it also has utility assets, a space in which the use of leverage tends to be a bit more prevalent. So 4.8 times isn't unreasonable based on the makeup of the company's portfolio.
It's also worth noting that Enbridge's leverage has spiked dramatically higher a couple of times; the most recent peaks was tied to the company simplifying its business by acquiring controlled partnerships. But, unlike Plains, those spikes didn't lead to dividend cuts. Enbridge appears to have a much better handle on its balance sheet, and, all in all, this issue is likely best seen as a wash.
4. Future growth
Plains is expecting to spend around $1.3 billion on capital projects in 2020, with a "meaningful" reduction in 2021. That spending is expected to support a roughly 4% increase in adjusted EBITDA in 2020. With a number of projects set to come online later in 2020 and 2021, it's reasonable to expect a similar EBITDA boost in 2021. Beyond that, however, with a drop in spending, it is hard to make a call. The distribution is likely to grow roughly in line with EBITDA.
Enbridge has plans to spend around $11 billion through 2022, with capital projects spread across its various businesses. Assuming everything works out as planned, the company is also projecting distributable cash flow growth in the mid-single digits in 2020. Thereafter, Enbridge believes it can continue to see increases in the 5%-to-7% range on an ongoing basis as it invests in its large and diverse collection of assets. Like Plains, the dividend is likely to increase along with distributable cash flow. This is a slowdown from the company's historical dividend growth rate, but does not include acquisitions, which have been a key part of the company's history.
Although you can't count of Enbridge making acquisitions, it is probably appropriate to consider the current growth projections a base-case scenario. Given the history of Plains and Enbridge, it looks like Enbridge has a more promising outlook.
Which one wins?
The duo of distribution cuts at Plains All American is a big negative, and should cause conservative investors alarm. Management has done a good job of (finally) getting the partnership back on track, but most income-focused types would be wise to wait a little longer to ensure that this midstream player has really turned a corner. The partnership's investment plans after 2020 are a key issue to monitor. All in all, however, there are other options in the space that have similar yields and better operating and distribution histories.
Enbridge, meanwhile, isn't exactly an apples-to-apples comparison. It has a larger and much more diversified business, which should be a major plus for conservative types. (Obviously, however, if you want a pure-play midstream company Enbridge won't be a good fit.) Add in a more consistent dividend history, and the slightly lower yield seems like a worthwhile concession. If you are looking at this pair, Enbridge is likely to be the better option today.