The energy sector is a key part of the inflation problem today, as rising prices for oil and natural gas are causing ripple effects across the world. However, the energy industry is broad and complex, and investors need to think carefully about where they put their cash lest they end up exposed to more risk than they expect. Enbridge (ENB 0.23%) is an interesting high-yield energy name that even conservative investors could love.
The basics of the business
Based in Canada, Enbridge's midstream business spans across North America. It helps energy companies that drill for oil and natural gas move, store, process, and export these commodities. This is an important distinction, because financial results for oil drillers tend to be very volatile since they are driven by commodity prices. Enbridge, on the other hand, simply charges fees for the use of its assets. That means that the price of what is flowing through its system is much less important than the volume that is flowing through it.
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This tends to lead to very consistent financial results across time for Enbridge. Notably, in 2020 when oil drillers were suffering under the weight of weak commodity prices, Enbridge's distributable cash flow actually increased 2%. There's a reason why it has reached the Dividend Aristocrat space with 27 consecutive years of annual dividend increases behind it. Add in the generous 5.7% dividend yield and there's a lot to like here even after a notable 20% increase in the stock price over the past year.
Rising prices
The problem with this picture today, however, is that oil and gas producers provide an inflation hedge because the price of what they sell is going up. It is, as noted, one of the main causes of inflation today. That's great for the producers, but it suggests that Enbridge's results won't be able to provide the same protection to investors.
In some ways that's true. Enbridge's toll-taker model won't benefit as much as an oil and gas producer. But that doesn't mean that Enbridge will suffer materially from rising costs. In fact, the company's contracts generally have inflation protection built into them. To put a number on that, management estimates that 80% of its earnings before interest, taxes, depreciation, and amortization (EBITDA) is protected in some way.
There are two primary ways this is handled. From a contract standpoint, roughly 65% of EBITDA has built in "revenue inflators." That means Enbridge has scheduled price increases that will offset the impact of rising costs. Another 15% EBITDA has "regulatory mechanisms" attached that allow Enbridge to recover rising costs.
It's pretty clear that 80% is less than 100%, so Enbridge won't be able to fully avoid the impact of rising prices. But then neither can oil drillers, which have to pay higher salaries to their employees and, in a hat tip to Enbridge, higher fees to move their products. Thus, for investors who want to own an energy name but really don't want to deal with the commodity risk of an oil and gas producer, Enbridge is still a great option, even in the face of inflation.
A lot more to the story
Roughly 84% of Enbridge's EBITDA is tied to oil and natural gas pipelines, so its midstream business is clearly the most important one to watch. That said, there's more going on here than just midstream; the rest of the portfolio includes a natural gas utility (12% of EBITDA) and a growing clean energy business (4%), which provide some diversification to revenues and, notably in the case of clean energy, growth opportunities. Add in the inflation protection, high yield, and strong dividend history, and investors should find this an even more intriguing energy stock. It will never be exciting, but that's by design. If you are a fan of slow and steady, it is worth a deep dive even as inflation rages higher.
