In 2020 I switched out of ExxonMobil (XOM 2.97%) and into Total (TTE 3.50%), capturing losses and shifting into a European energy giant that's working toward a cleaner future. In March I found another energy name to add to my portfolio, only this time it's based in North America and, like Total, is already working on building a renewable power business. Here's why retirees might like Canada's Enbridge (ENB 2.60%) as much as I do.
The problem with Exxon
I don't actually dislike Exxon, but it is definitely running counter to the clean energy zeitgeist. And when the stock fell in 2020, and I needed to capture some capital losses to offset gains elsewhere in my portfolio, I sold. It was a chance to re-evaluate my position on the energy sector.
Exxon's stance, and one that I agree with, is that oil and natural gas will be vital to the world's energy needs for years to come. However, it's hard to deny that renewable power is an increasingly important component, as well. Since I didn't want to exit the energy sector, I decided to buy Total, which had laid out a plan to use its energy business as a cash cow so it could gradually increase its "electrons" business.
I still like Total, but I've been looking at the North American midstream sector and trying to find a name that I felt was worth adding to my portfolio. This fee-based niche of the broader energy space has been offering high yields, but growth is likely to be difficult to come by over the near term because of low oil and natural gas prices (and thus weak demand for drilling and new pipelines). And then there's the concern about the broader shift toward renewable power to consider. For months I did nothing, watching the companies and master limited partnerships in the space and rolling the options around in my head.
And then, just recently, I watched the full three-hour recording of Enbridge's investor day after going over Enbridge's full-year 2020 earnings conference call. I should probably consider a hobby, since I did this, and some more research, on a weekend. But I was sold, and on the following Monday I bought the stock.
Core and explore
I would be lying if I didn't mention yield as a major reason for my purchase. Enbridge currently offers a very generous 7.2% dividend yield. Equally important, however, is that the company has increased the dividend every year for 26 consecutive years, which puts it into the Dividend Aristocrat space. That streak, by the way, includes a roughly 10% hike in 2020 and an already announced increase of 3% for 2021. The company targets a distributable cash flow payout ratio of between 60% and 70% and expects to be in that range this year, so the payout looks well supported.
The hike in 2020, meanwhile, gets to another key fact for me: Enbridge muddled through the coronavirus pandemic-related oil downturn in relative stride. Although earnings were, not shockingly, lower year over year, distributable cash flow increased from $4.57 per share in 2019 to $4.67 per share in 2020. That was roughly the midpoint of the company's 2020 guidance, which was provided before the pandemic hit. That's a pretty strong showing in the face of adversity and gave me material confidence in its ability to sustain the dividend through thick and thin. Indeed, 2020 was a stress test that many midstream companies didn't pass.
The real kicker here, however, is what I'm buying. Around half of Enbridge's business is tied to moving oil. It has an entrenched position via its Mainline System that is vital to the industry and, even with only modest expansion efforts, is a cash cow for the business. About 30% of the company is dedicated to natural gas pipelines, with a material presence in the Northeast where demand is high and supply is limited. Natural gas has been, and will likely remain, a key transition fuel as the utility sector moves away from coal. Another 10% or so is tied to a natural gas utility business that keys in on the same basic trend, as natural gas displaces other heating options. And the remainder of the portfolio is electricity, with a growing focus on offshore wind in Europe. That offers a direct clean energy angle that is slated to grow in importance over the next few years.
Almost all of Enbridge's business is fee-based or backed by long-term contracts. The total collection, meanwhile, provides a similar approach to the one that Total has taken. Basically the oil cash cow is helping to build out businesses that have better long-term prospects, including renewable power. That's a story that I found very compelling from a company that's proven it can handle a major industry downturn and still keep growing. On that front, meanwhile, Enbridge believes it can continue to invest between $3 billion and $4 billion a year in organic growth projects to drive distributable cash flow growth of 5% to 7% a year at least through 2023, if not longer. Dividend growth should trail along in a similar, but slightly lower, range. My concern about growth in the midstream space doesn't seem to apply here, assuming management is even close to accurate.
I jumped in
Having spent some extra time getting to know Enbridge a little better, I decided it was the midstream energy stock I was looking for. You might think so, too, given its strong business, lofty and well-supported dividend yield, and its growth prospects, including in the renewable space. There are some warts, like a high level of leverage (which has long been the case, but has historically been well managed) and the fact that dividends are paid in Canadian dollars, so what U.S. investors actually get will vary with exchange rates. But no stock is perfect, and those are imperfections I can live with. All in, my top energy pick today, for retirees or just about anyone, is easily Enbridge.