North American midstream giant Enbridge (ENB -3.33%) distributes a fat dividend that today yields 8.2%. But that pales in comparison to smaller peer Magellan Midstream Partners (MMP 0.90%), whose distribution right now yields a huge 12%. Both have decades of annual disbursement hikes under their belts, and both operate in the same sector, but they are far from interchangeable as investments. Here's what you need to understand before you simply buy the higher yield.
Big and little
Canadian Enbridge sports a market cap of nearly $61 billion, dwarfing Magellan's $7.6 billion valuation. Magellan is an important industry player in the North American energy industry, but it just doesn't have the same scale. For example, Magellan's business is largely in the pipeline space, where it's split about 60%/40% between refined products and oil. Enbridge's business includes oil pipelines (about 55% of adjusted EBITDA), natural gas pipelines (27%), natural gas distribution (13%), and renewable power (the rest). It wouldn't quite be accurate to suggest that Enbridge is massively more diversified, but it does have its fingers in more pies.
This has some material implications today. While Magellan has a long history of conservative and consistent growth behind it, the pandemic-related plunge in fossil fuel demand has upended the North American midstream market. Less crude oil and natural gas being pumped means less fuel moving through pipelines, which means lower fees for pipeline operators and reduced need for new midstream assets. Magellan's capital spending in 2020 is expected to be just 40% of the roughly $1 billion it spent in 2019.
The master limited partnership's capital spending plans haven't been this low since 2012. Next year looks even worse, though management states that it has as much as $500 million worth of projects in the wings. That's only valuable, however, if the energy sector recovers and the company can get those projects off of the drawing board. Which is one of the key differences between Magellan and Enbridge today.
Enbridge expects 2020 to be a tough year, too. For example, its outlook on distributable cash flow ranges from a decline of 1.5% to an increase of 5%. Basically, there's material uncertainty in key parts of its business, and how matters resolve will make a significant difference to its top and bottom lines. However, management expects annual distributable cash flow growth to average between 5% and 7% a year through 2022. And it has the projects lined up to back up that prediction.
Overall, Enbridge has around 10 billion Canadian dollars worth of projects in process right now that will run through 2022. It's already laid out about 45% of that. The projects span its entire business, with most of the spending going toward oil and gas pipelines, as you would expect, and comparatively smaller amounts being spent on renewable power and gas distribution. The key, however, is that these are all projects that are underway right now and largely backed by customer commitments or needed upgrades. It expects the projects, in total, to add $2.5 billion to EBITDA. Is that an iron-clad guarantee of success? No, of course not. But Enbridge clearly has more growth lined up than Magellan today.
That said, there's a caveat here. Enbridge has a long history of using leverage more aggressively than Magellan. To put a number on that, Enbridge's financial-debt-to-EBITDA ratio sits at around 7 today. Magellan's ratio is less than half that figure -- 3.2. This isn't an anomaly: Magellan has long had one of the most conservative balance sheets in the midstream space. So far, that extra leverage has worked out well for Enbridge and its shareholders, but leverage does limit a company's financial flexibility when times are tough. So this is a risk that investors need to consider.
Adding it all up
Magellan, perhaps true to its more conservative approach, is pulling in its horns as it waits to see what happens in the energy sector before making any big commitments. Enbridge, on the other hand, has big projects spread across its business that it is happily building right now despite the energy industry downturn. Unless there's a major hiccup, Enbridge should continue to grow its business over the next couple of years while Magellan will be stuck on pause. The prospects for the future here are a key reason why Magellan's yield is so high, noting that management has even been cautious in its comments about the distribution. In the end, Magellan's caution could leave it behind more aggressive players like Enbridge, assuming the energy sector comes out of its current funk soon. For growth-minded dividend investors, then, Enbridge is likely to be the more appropriate choice.