Enbridge: Why Returns Could Be Lackluster Going Forward (NYSE:ENB)

The shares for Enbridge Inc. (NYSE:ENB) have heavily declined over the last couple of months as it announced a major acquisition of Dominion Energy (D) gas utilities. The deal was valued at $14 billion and has gotten the disapproval of the markets. The deal is as much as ENB has generated in earnings in the last 4 – 5 years. All of the earnings won’t be going towards financing the deal, since a large part of the capital allocation strategy for the business is to deliver a strong dividend yield for investors. The company has raised the dividend for 28 years consecutively, which has yielded investors good returns during those years. The 5-year average raise is over 5% but this new deal may put a hold on raising the dividend at a similar rate. Valuing the company based on p/fcf is showcasing a significant premium. With more debt on the books, less FCF will be available to investors and that skews the valuation of ENB to the upside right now. I don’t like the price point but have to admit holding shares still has some value.

Business Performance

ENB has been very good at diversifying its business operations and right now has 5 various segments within the business, those being: liquid pipelines, Gas Transmission and Midstream, Gas Distribution and Storage, Renewable Power Generation, and Energy Services. The company has recently been moving more and more towards renewables as the investments into offshore wind farms for example. The market seems to have turned sour though towards ENB as the share price has dropped over 20% in the last 12 months alone.

Since 2016 the total assets for ENB have more than doubled and during this period the ROA has made strong improvements as well. Back in 2016, the ROA was barely above positive, but right now is at 2.34%. This improvement has been great to see as it means ENB has been successful in integrating their additional assets and leveraging them into stronger earnings.

During the same period, the FCF has made a lot of progress as well. In 2015 they were deep in the negatives by over $5 billion. Now they are over $6 billion and have been a significant driver for the dividend increase over the last few years.

Going back to 2012 the capital appreciation and dividend growth for ENB has been roughly 12%, yielding a market-beating return. However, I think that going forward, it won’t be as fast, unfortunately. When ENB is making deals like acquiring the gas utilities of D for $14 billion the capital left over to raise the shareholder value is further limited. For the medium term though, ENB sees the EBITDA grow at a 5% annual rate. This lack of strong growth I think has also been a key contributor to the share price diving as low as it has recently.

The commodities ENB transports have experienced significant price volatility in recent years, making for quite the roller coaster ride. This volatility applies not only to crude oil but is especially pronounced in the case of natural gas. Many are likely aware that the Russian invasion of Ukraine caused natural gas prices to skyrocket, exceeding $9/MMBTU at one point, only to later plummet and stabilize in the mid-$2s range.

Dividend Evaluation

The dividend for ENB has been a key point for investors to be watching. The company has been increasing it quite quickly over the last few years and has a cash dividend payout ratio of 90% right now.

The p/fcf has been steadily declining over the last decade and right now sits at the lowest multiples in the company’s history, but still exhibits a quite significant premium to the rest of the sector in my view. Compared to the broader sector median it has a premium of over 53% based on earnings on a FWD basis. Historically, ENB has traded quite high at a p/e of 17, which is 10% above current levels. Compared to a peer like Enterprise Products Partners L.P. (EPD) ENB looks quite expensive. EPD has a p/e of under 11 and a p/s of 1.18. These are both quite a bit lower than where ENB is at. On the dividend side, they are both above 7% but with the lower valuation of EPD, it seems to offer lesser immediate downside risk and becomes a more favorable investment in my opinion.

As far as my views on the dividend and increasing it go, I think that ENB will face struggles on this front. The company makes a significant amount of its revenues from natural gas as it holds a vast network of pipelines. But what I think is also true is that natural gas prices won’t see the same type of prices as they did in 2022. The war in Ukraine scared the markets and caused significant price appreciation. Right now they are subdued but trending slowly upwards. The same type of momentum won’t be noticed and therefore ENB can’t raise the dividend the same way as before. Estimates are that a 1.9% yearly increase will happen up until 2025, landing at $2.78 per year, or an FWD yield of 7.93%. With ENB also trading at such a high multiple based on both p/e and p/fcf I think investors aren’t getting the best possible deal and the risk of the share price falling further is high right now.

Risk/Reward

One notable concern that warrants attention in the context of ENB is the relatively subdued enthusiasm surrounding offshore wind energy compared to other renewable sectors like solar. While solar energy has garnered significant attention and investment, offshore wind has not received the same level of fervor. This difference in investor sentiment can, in part, be attributed to political considerations rather than purely economic or efficiency-driven factors.

If you’ve been an ENB shareholder for the past decade, you might have noticed that your returns haven’t been particularly robust. One of the primary factors contributing to this lackluster performance is the company’s substantial debt burden and the issuance of a significant number of shares, which has cast a shadow over its investment appeal. The investment appeal seems to come from the 7.65% dividend yield currently.

With share dilution happening at a continued rate I don’t think suggesting a buy right now is very wise. With the share price decrease, ENB is also getting less value from diluting shares and may be forced to accelerate the practice. This would just create a downward spiral of the share price declining in my opinion.

Key Notes

ENB has started to broaden its asset base even further with accelerated investments in renewables. I think however that the returns on this will be lackluster. The dividend I also think won’t be increasing the same way as in previous years which makes ENB even more expensive right now in my view. The best course of action seems to be to wait for better entry prices and a hold rating will be my final verdict.