Enbridge Offers A 7%+ Yield And Double Digit Total Return Potential (NYSE:ENB)

Lately, I’ve been writing a lot about rapid compounders with high dividend growth potential because I believe that the fundamental growth generated by these types of companies is likely to provide outperformance over the long-term. However, there’s still a place for high yielding stocks in my portfolio because of the peace of mind that they provide (especially during times of high volatility). High yield will be the focus of today’s article.

Right now, high yielding stocks make up about 9% of my stock portfolio.

I feel comfortable maintaining that weighting around the ~10% threshold right now, largely because I can generate ~5% “risk-free” yields with very liquid assets like money market funds and short-term bond ETFs.

Currently, my cash/cash equivalent allocation is ~12%.

So long as rates remain high, I’m happy to maintain a high cash position because of the reliable yields and the flexibility it provides (with the market near all-time highs, I like having a lot of dry powder to work with in the event of a macro pullback). But, with many analysts predicting several rate cuts this year, there’s a good chance that I’ll need to shift my cash allocation back into equities to maintain my current levels of passive income.

Therefore, I wanted to write a couple of articles putting a spotlight on my favorite high-yielding stocks.

Last week I wrote an article highlighting Realty Income (O) as my favorite high-yielding REIT.

I received a bit of pushback from readers, stating that ~5% isn’t high enough.

For some, that may be true. Everyone’s portfolio, risk tolerance, and desire for income is different. But for my portfolio, 5%+ is high enough.

Over the years, I’ve found that most yields above this level come with major growth issues and therefore, safety concerns.

Investors can get greedy chasing yield, just like they can when paying excessively high valuations when chasing growth. In both scenarios, the consequences can be dire.

I’m not interested in sacrificing quality for yield because those types of trades tend to result in the loss of principal over time. I’m not interested in chasing yields just so I can lose money. Instead, when thinking about high yields, I want to own assets that preserve my capital (at the very least) while providing safe and reliable dividends.

Well, the fact is, none of the higher yielding stocks in the real estate sector meet my safety/quality thresholds right now, so Realty Income is as good as it gets in REITdom.

But, REITs aren’t the only high-yielding investment vehicles in the market. There are other sectors to own. And today, I want to focus on an energy stock that I really like with a 7.3% yield: Enbridge (NYSE:ENB).

This is an undervalued blue chip that offers not only a high yield, but also an attractive risk/reward from a valuation standpoint, pointing towards a double digit total return potential.

Why Enbridge Is My Favorite Pipeline Play

Anyone who follows my investing strategy knows that I love companies with toll booth-like business models.

There’s nothing better than sitting back and collecting fees on the large-scale transaction volumes generated on wide moat networks while being agnostic to the goods/service being purchased.

I’ve talked about financials, such as Visa (V), Mastercard (MA), Intercontinental Exchange (ICE), and CME Group (CME) as asset light compounders that fit this mold.

Well, Enbridge operates a toll booth-like model as well.

It’s not an asset light company.

On the contrary, ENB owns an enormous portfolio of hard assets that span North America and Europe. There are both pros and cons to this. However, at the end of the day, I sleep well at night holding a large ENB position because this is a rare energy company that generates income based upon global energy usage and not the price of oil.

As someone looking for predictable, reliable passive income, I much prefer this business model as opposed to the more price sensitive situations offered by oil companies that are in the business of energy exploration and production.

There are significant capex requirements to maintain ENB’s massive hard asset empire; however, these costs haven’t prevented this company from throwing off significant cash flows.

As you can see, ENB’s distributable cash flows continue to be on a nice, upward trajectory.

And looking at the company’s strong asset/customer base (98% of its EBITDA is generated by toll booth-esque contracts and 95% of its customers carry investment grade credit ratings) and the long-term global energy demand outlook, I expect to see this trend remain in place.

Over the long-term, rising global GDP is expected to result in rising energy demand.

Rising economic activity and population growth support the thesis for ongoing energy consumption.

According to Statista, global energy demand is expected to grow at a steady pace over the coming decades.

And with that in mind, I expect to see a well diversified company like Enbridge continue to grow its cash flows and sustainable return cash to shareholders.

Overall, ENB separates its business into four primary operation segments:

• Liquid Pipelines
• Natural Gas Pipelines
• • Gas Utilities and Storage

Liquids Pipelines

Enbridge owns/operates more than 17,800 miles of liquids pipelines in the US and Canada. This vast network transports roughly 30% of the crude oil produced in North America. ENB transports roughly 65% of the US oil imports from Canada. Enbridge hasn’t announced Q4 results yet, but in 2022 they set an all-time company record moving over 4.3b barrels of oil with an impressive 99.99996% safety record. With DCF headed higher in 2023, I expect to see another new record in 2023.

Natural Gas Pipelines

Enbridge has kept an eye on the future with heavy investments into its natural gas transport network over the years. Today, it owns/operates nearly 73,800 miles of natural gas/midstream pipelines. ENB move about 20% of all natural gas consumed in the US. It also has roughly 274 billion cubic feet of working storage for natural gas across its network. ENB has also focused on liquified natural gas (LNG) and has a ~15% market share in the Gulf of Mexico (which is expects to roughly double in size by 2030 due to rising demand). Rising global demand for LNG is leading to rising exports and ENB has invested in port assets as well, allowing it to benefit from this trend.

According to the IEA’s medium-term gas outlook, most of the demand growth for natural gas is going to come from outside of the US (mainly, from Asian countries).

Enbridge’s investments in ports, terminals, and other export-related assets means that they’re still well situated to benefit from his growth, even if demand in North America is expected to be relatively flat over the short-to-medium term.

Gas Utilities and Storage

Something that sets Enbridge apart from many of the other MLPs is their diversified business model which has focused on utilities and renewable energy generation.

2023 was a big year on both fronts. In September, ENB announced a $14 billion acquisition of 3 US gas utilities, creating the largest natural gas utility network in North America.

The new additions to ENB’s portfolio (the East Ohio Gas Company, Questar, and the Public Service Company of North Carolina) will provide 9.3 bcf of gas per day to roughly 7 million new customers for ENB.

Overall, the company is focused on investing in areas with favorable regulatory environments and attractive population demographic trends.

ENB expects to see these investments generate ~8% annual growth for investors over the long-term, due to rising demand in these areas.

ENB’s gas distribution segment also includes its Canadian utility portfolio, which largely serves Ontario (where roughly 75% of residents are ENB customers). Ontario’s population is expected to grow by ~2.5 million people over the next 10 years. That bodes well for ENB’s utility connections upward growth trajectory.

These utility operations provide reliable cash flows and once again, isolate ENB from volatile oil prices. So does the company’s renewable investments.

Renewable Energy

While other midstream names are using their excess cash flows to buy back shares, ENB continues to look towards the future, diversifying its revenue steam with renewable energy investments.

Right now, these assets still make up a very small portion of ENB’s overall revenue pie; however, I really like the long-term mindset that this company has when it comes to staying relevant in the future energy markets.

Due to climate change fears, rising ESG concerns, and technological advancements that are lowering the costs and raising the efficiency of wind/solar power generation and storage capabilities, it’s fairly clear (to me, anyway) that fossil fuels are going to see demand pressures over the coming decades.

Resources for the Future recently published a report showing the varying energy outlooks published by different energy companies and international agencies related to different climate/carbon plans and all of them arrived at similar conclusions.

While the different studies and future scenarios resulted in different paces of declines, they all pointed towards lower oil and natural gas demand between now and 2050.

Furthermore, while different studies varied in their 2050 estimates, they all agreed that electricity demand is going to see significant increases over the coming decades.

Lastly, they also agreed that renewables, such as wind, solar, and hydrogen, will be the primary energy sources used to meet with growing electricity demand.

And therefore, it seems prudent to me that Enbridge is investing in wind/solar resources.

As you can see, ENB has been busy in this space in recent years. According to the company’s Investor Resources website:

Overall, ENB’s renewables portfolio has the capability of generating 2.37 megawatts of net energy…which can power 1,144,900 households.

The company expects to see its offshore wind portfolio to grow its EBITDA “significantly” in 2024 and that is factoring into the company’s higher forward-looking guidance.

Reliable Cash Flows And Dividends

The combination of these four segments has allowed the company to generate reliable growth, throughout a wide variety of energy markets, which is why it’s one of my favorite high yielding stocks.

Enbridge recently raised its dividend by 3.1% (from CAD 0.887 to CAD 0.915). Obviously for US investors there are forex considerations here, but using its native currency, ENB has now raised its dividend for 29 consecutive years.

That’s the type of history that I’m looking to see when investing in a high yield stock.

And when a company like ENB is yielding north of 7%, it doesn’t take much in terms of stock price appreciation to result in strong total returns, overall.

ENB shares have struggled in recent years (they’re down by nearly 13% during the past year and they’re basically flat over the last 5 years).

However, throughout this period of relative underperformance, ENB’s adjusted EBITDA and its DCF/share continues to rise, leading me to believe that shares are undervalued.

5 years ago, ENB’s EBITDA was $4.82/share. It’s expected to be roughly $5.70 for the full-year in 2023 and $6.00/share by the end of this year.

Therefore, earnings have risen by ~18% (comparing the 2018 total to the 2023 estimate) while the share price has gone nowhere.

As you can see here, ENB’s average P/EBITDA has been in the 8.5x range throughout the past decade.

Well, today that multiple sits at just 6.3x.

Multiple expansion back up to that 8.5x area would result in a share price in the $48 area (or, in other words, capital appreciation of 34%).

I’m not going to hold my breath as I wait for that sort of rally to play out, but I think these shares are a bit of a coiled spring down here in the 6x area.

Even if you discount that historic multiple because of today’s higher interest rate environment and place a 7x fair value multiple on EBITDA, ENB shares are worth ~$42/share on a forward-looking basis.

Looking out a few years, this discounted 7x multiple would still result in a ~15% total return CAGR.

You see, on a forward-looking basis ENB expects to see its EBITDA and its DCF/share to continue to rise.

These rising profits are expected to support ongoing dividend growth as well.

ENB’s DCF payout ratio continues to hover in the 65% area (within management’s target range of 60-70%.

With that in mind, alongside the ongoing DCF growth guidance, I think ENB has the potential to continue to provide 2-3% annual dividend growth while still meeting all of its debt servicing, capex, and investment goals.

That growth protects the purchasing power of this 7.3% yield from being eroded away by inflation over time.

That’s very important to me when making income-oriented investments as a long-term investor.

Risks

No stock is perfect and there are risks that investors need to consider with Enbridge:

1) Any significant changes in global energy demand trends could hurt its profit outlook. For instance, if fossil fuel demand is much lower than expected, that will change the company’s profit outlook, because while ENB is being forward thinking with it renewable investments, they are still a small piece of its business.

2) Ongoing legal issues related to the political climate between the US and Canada, from an energy trade point of view, could impact its cash flows (for instance, the state of Michigan has sued Enbridge in the past about its Line-5 pipeline rights in the past and shutting down this route would hurt Enbridge’s volumes). However, Canada has argued that international treaties supersede state-level decision making and while left-leaning politicians from Michigan have fought against Enbridge’s projects in that state, these issues have been going on for years, there has been little disruption to Enbridge’s operations and it appears that the complaint could be little more than political posturing (because Michigan residents needs the energy that Enbridge ships to maintain their lifestyles).

3) Rising interest rates could negatively impact Enbridge’s profit outlook due to the company’s high debt load. However, it appears that management is going a good job managing its balance sheet. Enbridge has a BBB+ credit rating from S&P Global and its debt to EBITDA ratio has fallen from 5.1x to 4.1x over the last year.

Conclusion

Overall, I’m more than happy to hold my undervalued shares of this high yielder and collect ENB’s rising dividend while I wait for the share price to catch back up with the fundamental growth.

Heck, even if ENB doesn’t experience multiple expansion via mean reversion and continues to rise in the 6.5x EBITDA area, the stock’s 7%+ yield + its ~6% adjusted EBITDA CAGR expectations point towards a total return CAGR of ~13% over the next several years.

Either way you slice it (multiple expansion or not), ENB’s depressed share price and high dividend yield point towards total returns above that 11% long-term average.

That’s not bad at all for a relatively boring, predictable, low beta, toll booth-like play from the energy space.