Enbridge (NYSE: ENB) it’s not an exciting company, but it’s actually one of the biggest attractions here. That and an extremely high dividend yield of 7.4%. But to really appreciate why you’ll be glad you bought this stock in a few years, you need to take a deeper look at its business and how it returns value to investors over time.
Enbridge is more than just a midstream giant
The energy sector is notoriously volatile, but not every company in the industry deserves that label. Upstream (drilling) and downstream (refineries and chemicals) businesses are often quite volatile, but mid-tier companies like Enbridge usually aren’t. This is because the midstream companies own the energy infrastructure (like conduits) that connect upstream with downstream, and the rest of the world, and charge a large fee for the use of their assets.
Enbridge is, basically, a toll collector. And since oil and gas are vital to the smooth running of the world, demand tends to remain strong even when energy prices are weak. Oil pipelines account for about 50% of earnings before interest, taxes, depreciation and amortization (EBITDA) while natural gas pipelines make up about 25%. This is where the next interesting fact about Enbridge arises.
The rest of the energy giant’s business comes from regulated natural gas utilities (22% of EBITDA) and renewable energy investments (3%). Natural gas is cleaner than coal or oil and is considered a transition fuel. Enbridge recently agreed to buy three natural gas utilities from Dominion Energy, which increased its exposure to this energy position from 12% to over 22%. Controlled public utility assets obtain a monopoly in the areas they serve, in exchange for an obligation to receive interest rates and investment plans approved by the government. This tends to lead to slow and steady growth over time. In short, Enbridge’s business is even more reliable thanks to this investment.
Then there’s the renewables business, which is pretty small relative to the rest of the company. But then clean energy is still a relatively small piece of the global energy pie, too. The fact that Enbridge is expanding into space is basically an attempt to use its coal fuel profits to change with the world as clean energy becomes more important over time. It represents a hedge, of sorts, for investors who aren’t ready to jump into renewable energy but recognize its growing role in the world.
What can investors expect from Enbridge?
So Enbridge is a boring midstream company that is slowly changing its operations in a cleaner direction. That’s not exactly an exciting story until you consider the whopping 7.4% dividend yield. Most investors expect the stock market as a whole to provide returns of about 10% annually, so Enbridge’s dividend alone gets you about three-quarters of the way there.
That dividend, meanwhile, is backed by an investment-grade balance sheet. And the distributable cash flow payout ratio is right in the middle of management’s target range of 60%-70%. Also, the dividend has increased annually for 29 consecutive years. This is a reliable dividend stock and there is no reason to believe that the dividend is at risk. In fact, it seems very likely that slow and steady dividend growth in the low single digits is a reasonable expectation.
So if the dividend increases roughly in line with inflation, at about 3%, the total return investors can expect is probably about 10%, adding the current 7% yield to the dividend growth of about 3%. Stocks normally grow along with their dividends over time to keep yield consistent, so market-like returns from this high-yielding stock aren’t an unrealistic expectation. It’s hard to complain about that, especially if you reinvest your dividends, which allows them to grow over time.
The basis for Enbridge is good
It seems likely that Enbridge can get away with just doing what it’s doing. This will be enough to provide stable returns to investors as noted above. But what’s interesting here is that Enbridge’s dividend yield is historically high today. So it actually looks like it may be trading at a depressed price.
It is entirely possible that this situation will not change and that the yield has simply increased to a new range to reflect Enbridge’s business as it is today. However, if Wall Street suddenly becomes more interested in the company, investors who buy today will get a boost from increased demand for the stock. The base case is Enbridge’s boring business producing market-like returns, while the upside could be much higher. This seems like an attractive risk/reward balance that you’ll regret missing out on if you don’t jump in soon.
Should you invest $1,000 in Enbridge right now?
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Reuben Gregg Brewer has positions at Dominion Energy and Enbridge. The Motley Fool has positions and recommends Enbridge. The Motley Fool recommends Dominion Energy. The Motley Fool has one disclosure policy.
A few years from now, you’ll wish you’d bought this undervalued, high-yielding stock originally published by The Motley Fool
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