The world is slowly moving away from dirtier energy sources toward cleaner ones. Enbridge (ENB -1.21%) has been following along with that transition. Its latest move, the proposed acquisition of three natural gas utilities from Dominion Energy (D -1.02%), moves the company further down that path. But investors don't seem to like the deal. That could be a buying opportunity for long-term investors.
Enbridge is shifting the mix
In 2016, nearly three-quarters of Enbridge's earnings before interest, taxes, depreciation, and amortization (EBITDA) was derived from its oil pipelines. Over the years, it has invested in natural gas assets, including the acquisition of Spectra Energy, which reduced oil to around 57% of EBITDA. Natural gas exposure across a mix of pipelines and natural gas utilities rose from 21% to 40%.
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The company's proposed $14 billion acquisition of three natural gas utilities from Dominion Energy is expected to reduce oil to 50% of EBITDA while increasing natural gas to 47%. For reference, the company's renewable power investments make up the remainder of EBITDA. Investors seem to have some concerns, pushing Enbridge's shares lower as soon as the news hit the street.
Here are some of the potential concerns investors might have with regard to the North American energy giant -- and why long-term investors might find the stock's recent weakness an attractive buying opportunity just the same.
Sticking to carbon fuels for too long
From a strategic point of view, there are concerns that Enbridge is still too reliant on carbon fuels in a world increasingly moving to renewable and clean energy sources. The purchase of natural gas utilities does nothing to change that narrative. However, natural gas burns cleaner than coal and oil. It is considered a transition fuel that will support the long-term shift toward renewable power.
While it would be nice if there were a switch that could be flipped to make the global energy industry clean overnight, it will likely take a very long time to transition to a drastically different energy infrastructure. Enbridge is betting that the assets it's buying will provide reliable cash flows for years while the longer energy transition plays out. It is not an unreasonable bet, given that there are very real concerns that governments are moving too slowly on their stated transition goals.
The company's growth is slow
Enbridge has a long-term target to grow distributable cash flow by around 5% a year. It has fallen short of that goal recently, with low-single-digit growth expected through 2025.
Adding these natural gas utilities probably won't change that near-term expectation very much, especially since the deal won't close until at least 2024. However, these regulated utility businesses come with very well-defined spending and growth outlooks, making Enbridge's future more predictable and, thus, enhancing the attractiveness of the long-growing dividend (it has been increased annually for 28 years).
With a generous 7.5% dividend yield, slow and steady business and dividend growth are hard to complain about, particularly if you are focused on maximizing the income you generate from your portfolio.
Financing the deal will require issuing stock
Enbridge expects to issue stock as part of the transaction. That's not uncommon for acquisitions and will help the company maintain its leverage within management's target levels. Although there is always the risk of shareholder dilution when stock is sold, Enbridge appears to be acting prudently to ensure its financial strength isn't compromised by its decision to act on an opportunistic acquisition.
Indeed, it isn't every day that a giant U.S. utility like Dominion undertakes a business review with the goal of selling large non-electric assets. All in all, there is probably a reasonable risk/reward balance here as Enbridge looks to take advantage of a unique opportunity.
Striking while the iron is hot
In some ways, Enbridge is taking a somewhat contrarian view of the energy transition. It is essentially betting that it will be slow and that natural gas will be a profitable investment for a long time.
With a goal of providing investors with a well-supported and slow-growing dividend, it seems like the deal to buy assets from Dominion is reasonable and being handled prudently. If you are looking for a reliable, high-yield dividend stock, Dominion's share price drop on the acquisition news could be a good opportunity for you to buy while others are fearful.
