With a huge $60 billion market cap, Canada's Enbridge (ENB 0.68%) is easily one of the largest midstream companies in North America. It currently offers a yield of roughly 8.3%, generous in any environment -- but particularly today, when the S&P 500 Index is yielding less than 2%. But these facts alone don't make Enbridge a buy. In fact, there are some pretty notable reasons to dislike the company. Here's what you need to know, and why the negatives aren't as bad as you may think.
1. That's a lot of debt
In the midstream space, a key leverage metric is financial debt to EBITDA. Enbridge's ratio here is about 7.1 times. That's up from a little below 5 times at the start of 2020. That's not an unusual increase, as companies throughout the industry (and the economy, frankly) took on debt to boost liquidity during the early days of the COVID-19 crisis. It's just good business sense to ensure that you have enough cash to muddle through when times get tough.
Image source: Getty Images
The real issue here is that even before the pandemic Enbridge's leverage was toward the high end of the midstream sector. More conservative peers, even after boosting leverage to ensure liquidity, are hovering in the 3 to 4 times financial debt to EBITDA space. Put simply, leverage is an issue to watch at Enbridge.
However, the midstream giant has long made greater use of leverage, so this isn't an unusual trend, and hasn't stopped the company from amassing an impressive history of rewarding investors with dividends (see below). All in all, this negative isn't as big a deal as you might at first think, and isn't a particularly compelling reason to nix the company from your wish list.
2. Can it carry that yield?
The fat 8.3% yield is one of the biggest attractions for dividend investors. The big question is whether or not the midstream giant can sustain the current payout. Sure, it upped the dividend by nearly 10% at the start of 2020, extending its annual increase streak to 25 consecutive years, but that was before the COVID-19 crisis. (Note that the dividend is paid in Canadian dollars, so the dividend U.S. investors receive will vary with exchange rates.)
Digging below the dividend, the company's distributable cash flow (DCF) dipped slightly year-over-year in the first quarter and rose slightly in the second quarter. So there's no clear trend there. However, taken together, the company's DCF payout ratio in the first half of 2020 was roughly 64%. The company's target is 65%. Even though things are a little uncertain right now, the dividend doesn't look like it's at any material risk. Again, there's no particular reason to avoid Enbridge because of its dividend.
3. Oil is a dying business
So far so good, but the real big issue hanging over the entire energy sector is that demand for oil and natural gas has fallen off a cliff in the face of COVID-19. That makes sense given the economic shutdowns used to slow the fast-spreading pandemic. However, low oil prices have also reduced investment in new production in North America, which reduces the need for more oil and natural gas midstream energy infrastructure, which together are Enbridge's bread-and-butter businesses, accounting for roughly 80% of EBITDA combined (the rest is made up of natural gas utilities and renewable power assets).
There are some clear headwinds, of course, but supply and demand will eventually get back into balance, as they have many times before. In fact, Enbridge, like many others in the industry, expects a growing world population, increasing urbanization, and generally rising living standards to lead to continued demand growth. To satisfy the world's need for power, an "all of the above" strategy will be required, including the oil and natural gas that green energy enthusiasts seem to loathe.
And that means continued expansion and distributable cash flow growth at Enbridge. Right now it has projects planned across its four business lines that will last through 2023. It has about CAD $5 billion to spend on these investments, which it projects will increase its cash flow by around CAD $2.5 billion. In other words, it's still full steam ahead for Enbridge as it looks to the long term. So that's another negative that does not appear to be as bad as some might fear.
Not so bad after all
When you look at three of the biggest knocks against Enbridge, you quickly see that the situation here isn't really all that bad. Sure, it's facing headwinds today, thanks to the coronavirus, but it's managing through this period with a long-term approach that seems strongly grounded. For dividend investors seeking out a high-yield in the out-of-favor energy space, Enbridge looks like a pretty good option today.
