Oil is not going to suddenly disappear So Enbridge's (ENB 0.68%) cash cow oil pipeline assets will likely be generating oodles of cash for years to come. But the North American midstream giant isn't sitting on its laurels, and the proof of that can be found in how it is spending its cash. Here's why Enbridge is a buy for income investors taking a long-term view of the energy sector.
Decades to go
There are different scenarios about what the future may look like when it comes to energy use. The U.S. Energy Information Administration (EIA) expects oil and natural gas demand to increase through 2050, with demand for carbon fuels rising 30% from 2020 levels. OPEC is projecting that carbon fuel demand will peak in 2030 and then sit at roughly the same level until 2050. The International Energy Agency (IEA) expects demand to peak around 2030 and then fall back to 2020 levels by 2050.
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The big carbon fuel loser in all of these scenarios is coal, which is among the dirtiest sources of energy. Oil and natural gas, by comparison, remain fairly resilient in each projection. In other words, ESG investors need to get comfortable with the fact that, unless something material changes, oil and natural gas are here to stay for a very long time. What's interesting, though, is that natural gas burns more cleanly than oil or coal. That is why it is expected to be a transition fuel between today's carbon-heavy options and renewable choices like solar and wind.
This is the lens through which you have to view Enbridge's portfolio. In 2022 roughly 57% of its earnings before interest, taxes, depreciation, and amortization (EBITDA) was tied to oil, with 40% involving natural gas and 3% clean energy. The Canadian company operates in the midstream niche of the energy sector, so it collects fees for moving oil and gas. That means that often volatile energy prices are less important than the still-strong demand highlighted above.
There's ample cash flow flowing to support the company's generous 6.7% dividend yield. And, notably, the company's distributable cash flow payout is roughly in the middle of the target payout ratio range of 60% to 70%, so there's plenty of room for adversity before the dividend would be at risk. The dividend has been increased annually for an impressive 28 years and counting.
More than oil
So there's a lot to like here for a dividend investor unless you are particularly focused on the eventual shift toward cleaner alternatives. Although oil is still important, the very long term will likely involve that particular fuel becoming increasingly less important relative to other energy sources. That remains true even if demand is strong since the demand for cleaner energy sources is most definitely increasing. But don't toss this high-yield stock out with the bathwater. A slightly deeper dive is needed to understand how Enbridge is adjusting for the future.
First off, the company's largest business is oil pipelines. That division of the company is slated to see roughly $1 billion in annual capital investments for the foreseeable future. That sounds like a lot of money, and it is, but compare that to the $3 billion slated to go to Enbridge's natural gas operations (which consist of pipelines and a natural gas utility operation). Clearly, management has big plans to expand in natural gas relative to its expectations with regard to dirtier oil. That means that the future for Enbridge is cleaner.
But the really big number comes from the company's clean energy business, which, like oil, is slated to see $1 billion in capital spending per year in the future. Compared to the spending on natural gas, this division sounds like it's less significant. But consider the spending relative to the current EBITDA contribution of this division, which is just 3%. When you take division size into consideration, clean energy is getting more money, relatively speaking, than oil or natural gas. It is highly possible that clean energy will be the fastest-growing division in the company, albeit from a low base.
Sounds familiar
All in, the way Enbridge is allocating its growth spending is roughly in line with the way the world is moving with regard to energy. Dyed-in-the-wool clean energy investors might not want to invest in this high-yield stock. But for income investors looking for a reliable dividend payer that is making intelligent decisions about how to deal with the changing energy landscape, it would likely be a very fine addition. The best part? The dividend yield is toward the high end of its historical range, suggesting that Enbridge's shares are historically cheap today.
