Contents
Summary
- This company has tested long-term investor patience over the past 3 years.
- Management has 5 strategic priorities, one of which is a simplified corporate structure. These initiatives are in various stages of progress and once completed should result in improved shareholder returns.
- Shareholders are rewarded with an attractive dividend that is well covered by Distributions from Cash Flow while waiting for the share price to appreciate.
- I view the shares as undervalued even though the share price has ticked up ~23% since late April.
- I will be acquiring another 400 – 500 shares within the next 72 hours for the FFJ Portfolio’s ‘side account’.
Introduction
All dollar values expressed in this article are in CDN dollars unless otherwise noted.
My rationale for adding shares in this company to the FFJ Portfolio several months ago was that it I saw huge future potential. This company operates in a highly regulated industry which results in significant barriers to entry. In addition, this is an extremely capital intensive business but once the infrastructure is in place the business is tantamount to a toll road…revenue literally flows in.
The subject company has certainly been extremely busy in recent months. It has:
- announced a simplification of its corporate structure;
- generated strong operational performance across all business segments;
- has ~$7B of new projects on track to come into service in 2018 of which $1.6B have been brought into service YTD;
- received additional regulatory approval for the issuance of the Certificate of Need and Route Permit for one of its major projects;
- has agreements to sell $7.5B of non-core assets which is well above the $3B original target for 2018. The sale of non-core assets will enable this company to accelerate de-leveraging thus providing it with increased financial flexibility so as to further focus on lower risk businesses.
Given all the activity that has transpired in recent months and the fact it has recently released its Q2 2018 results, I thought this would be an opportune time to once again review this company to ensure there is nothing that would cause me to change my initial thesis for investing in this company.
Business Overview
Enbridge Inc. (TSX: ENB.TO and NYSE: ENB) current structure certainly does not make it an easy company to analyze. Thankfully, one of the company’s strategic priorities is to simplify the corporate structure.
The following images provide a very high level overview of the company.
Source: ENB – Investment Community Presentation – July 12, 2018
Source: ENB - Q2 2018 Earnings Presentation – August 3 2018
Further details on each of the following 5 strategic priorities can be found in the July 12, 2018 Investment Community Presentation.
- Move to Regulated Pipeline & Utility Model
- Accelerate Deleveraging
- Deliver Reliable Cash Flow & Dividend Growth
- Streamline the Business
- Extend Growth Beyond 2020
Source: ENB – Investment Community Presentation – July 12, 2018
The business structure I presented in my August 7, 2017 article is about to undergo some significant change. In May 2018, ENB announced its plans to simplify its corporate structure. Formal proposals were made to the boards of each of ENB’s sponsored vehicles to acquire all of their outstanding public equity securities.
ENB holds a
- 9% economic interest in Enbridge Energy Partners, L.P. (NYSE: EEP);
- 7% economic interest in Enbridge Energy Management, L.L.C. (NYSE: EEQ);
- 75% equity interest in Spectra Energy Partners, LP (NYSE: SEP);
- 6% economic interest in Enbridge Income Fund (TSX: ENF).
The roll up is to be done through separate all-share transactions.
These sponsored vehicles were established so as to provide an attractive alternate source of funding and they were effective in optimizing ENB’s overall cost to capital.
This advantage, however, no longer exists and in December 2017, ENB rolled out its 3-year plan in which it made it clear to the investment community that one major priority was to streamline and simplify the corporate structure.
Subsequent to rolling out the 3-year plan, there has been a further weakening in the Master Limited Partnership (MLP) market. In addition to investor preferences moving away from high-payout vehicles, the cumulative impact that reduced or eliminated tax allowance put more pressure on both EEP and SEP, as it did on other MLPs, with a proportion of cost-to-service base rates.
In Canada, ENF's cost of funding has increased to the point where its growth will be challenged. Management’s view is that ENF is no longer a cost effective source of funding for ENB.
The benefits to be derived from this simplified corporate structure are:
- all core liquids and natural gas assets are investable to a streamlined ENB, where the stability, predictability and growth in cash flows are even more transparent. Having all core assets held within ENB should be able to attract a premium valuation;
- ENB will acquire more of what it already owns, namely, attractive energy infrastructure assets which carry a uniquely low risk profile;
- the recent Federal Energy Regulatory Commission tax policy and the U.S. tax reform changes no longer make the holding of assets in MLP structures advantageous to ENB. The roll-up of these MLPs will ensure ENB can maximize cash flow by recovering tax allowance;
- The restructuring should be positive from a credit and funding perspective because 100% of the cash flows generated by ENB’s assets will be kept in the ENB family and will not be disbursed through third-party distributions. This improved cash flow would also support capital investment.
The following shows how the proposed restructuring should benefit ENB shareholders.
Source: ENB – Simplification of Corporate Structure – May 17, 2018
Source: ENB - Q2 2018 Earnings Presentation – August 3 2018
Q2 2018 Financial Results
On August 3rd, ENB released its Q2 2018 results and updated its guidance for FY2018. Details can be found here.
(Note: ENB previously used ‘Available Cash Flow from Operations’ (ACFFO) but now uses ‘Distributions from Cash Flow’ (DCF). The calculation methodology remains unchanged.)
Source: ENB - Q2 2018 Earnings Presentation – August 3 2018
2018 Guidance
The following are the list of projects in progress or scheduled to proceed.
Source: ENB - Q2 2018 Earnings Presentation – August 3 2018
Credit Ratings
Moody’s initiated coverage in June 2001 at an A2 rating. After a few downgrades over the years, ENB is currently rated Baa3 (‘lower medium grade’); the most recent downgrade was in December 2017. This is the lowest investment grade tier.
S&P Global rates ENB’s senior unsecured long-term debt BBB+. This is the upper tier of the ‘lower medium grade’ and is 2 notches above non-investment grade. This is two notches higher than Moody’s assigned rating.
There is no disputing that ENB needs to reduce its leverage. Strategic priority #2 calls for:
- the strengthening of credit metrics as industry leading growth capital spend moderates and new projects generate significant EBITDA;
- long-term Consolidated Debt to EBITDA target of 5.0 times by end of 2018;
- possible further balance sheet strengthening from additional asset sale proceeds.
Clearly, de-leveraging will take some time but ENB is actively reducing its debt level. An improvement on this front should, hopefully, result in an improvement in its credit ratings.
In the interim, the credit rating agencies view ENB has having adequate capacity to meet its financial commitments.
Valuation
ENB’s TSX listed shares are currently trading at $46.53 (August 3, 2018 close of business).
ENB previously used the term ‘available cash flow from operations (ACFFO)’ in its earnings releases but this has been changed to Distributions from Cash Flow (DCF); the calculation methodology remains unchanged.
Management has indicated the company is on track to achieve financial guidance for 2018, with the outlook for DCF per share expected to be in the upper half of the $4.15 - $4.45/share guidance range.
On an EPS basis, the consensus current mean EPS estimate from 8 brokers is $2.49. The disparity in earnings projections, however, is significant ($2.19 - $2.70). ENB generated EPS of $1.66 and $1.95 in FY2017 and FY2016. Adjusted EPS amounted to $1.96 and $2.28 in FY2017 and FY2016.
Using the consensus current mean EPS estimate I arrive at a forward PE of ~18.7. (the ~17.2 – ~21.25 range is fairly wide).
If I use the DCF metric management focuses on, I get a forward Price/DCF range of ~10.46 - ~11.2.
When I wrote my August 7, 2017 article, ENB was trading at $52.57 and 2018 EPS expectations from multiple brokers was $2.56 thus giving us a forward PE of ~20.54. At the time of that article, management projected ACFFO of $3.60 - $3.90. Using the $52.57 price, the forward Price/ACFFO range was ~13.5 - ~14.6.
Using either metric we see that ENB’s valuation level is now more favorable for investors desiring to initiate/increase a position in ENB than when I wrote my August 7, 2017 article.
Dividend, Dividend Yield and Dividend Payout Ratio
Details about ENB’s dividend and dividend policy can be found here. At $0.671/share or $2.684/year, ENB’s current dividend yield is ~5.77%.
Source: ENB’s website
ENB’s dividend policy is appealing to me and I am confident that the changes being made at ENB will enable it to continue to reward investors with dividend increases comparable to the last several years.
The $2.684/year dividend is ~60.3% - ~64.7% of 2018’s projected DCF. This falls within ENB’s conservative <65% dividend payout ratio.
ENB’s Performance vs S&P500
Over the long-term ENB has performed well relative to the S&P500. Its performance relative to the S&P500 over a shorter timeframe, however, has certainly tested investor patience.
The following data is expressed in USD.
Source: TickerTech
In my opinion, all the strategic initiatives currently underway will improve ENB’s performance and I expect shareholders with a long-term investment horizon will be well rewarded. In the interim, ENB is rewarding patient shareholders with an attractive dividend.
Final Thoughts
ENB has certainly challenged investor patience for the last 3 years….even long-term value investors.
I am of the opinion that ENB’s fundamentals are about to get stronger which will lead to a higher stock price; ENB’s stock price has, in fact, ticked up since late April 2018 so I think investors are already starting to realize better days are ahead for the company.
I think that once ENB completes some of its major projects over the next couple of years it will be set for a multi-decade boom.
In hindsight, I initiated a position in the FFJ Portfolio just a tad early in August 2017. I am not concerned, however, as I acquired ENB for the long haul.
I like ENB’s strategic initiatives and continue to have utmost confidence in management. I, therefore, fully intend to acquire another 400 – 500 shares for the FFJ Portfolio’s ‘side account’ within the next 72 hours.
Based on the current $2.684 annual dividend this will generate an additional $1,073.60 - $1,342.00/year in dividend income which will be automatically reinvested to acquire additional ENB shares.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected]
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long ENB.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
