Enbridge: 3 Factors That Triggered Rating Upgrade (NYSE:ENB)

Earlier this year, I wrote an article comparing Enbridge (NYSE:ENB) with a closely related peer, Enterprise Products Partners (NYSE:EPD).

The analysis showed that both companies carry some attractive fundamental characteristics, which are critical for yield-seeking investors to have in order to capture growing streams of current income while keeping the financial risk in balance.

Yet, the final recommendation was to go long EPD and put ENB on hold. The motivation behind de-emphasizing ENB lay in the Company’s leverage and multiple, where both of these variables were at clearly more favorable levels for EPD.

Now, since the publication of the article, new data points have emerged, which are strong enough to trigger a rating upgrade.

In the sections below, I will discuss the key drivers for switching my stance on ENB from hold to buy.

Thesis update

First, let’s dissect the Q4, 2023 figures that were circulated to the public slightly after I issued the aforementioned article on ENB and EPD.

All in all, the results were stable across the board and largely in line with how the market priced in the consensus estimates.

Summing together all quarters of 2023, ENB managed to register an annual EBITDA and DCF increase of 6% and 1%, respectively, compared to the relevant figures in 2022. We cannot really distinguish one or two specific drivers of EBITDA growth, as the Management did a really solid job across all main segments of the business. Namely, liquid pipes, gas transmission & midstream, gas distribution & storage, renewable power generation, and energy services all experienced somewhat even growth both during Q4 and in aggregate of 2023 (with an exception in Gas Transmission & Midstream segment during Q4, where a minor contraction was observed).

What is worth underscoring, and is also present in the Q4 data, is the different dynamics of EBITDA and DCF results. As indicated above, ENB managed to step up its EBITDA generation by 6% in 2023, which enabled DCF to move up by only 1%. Comparing Q4, 2023 to Q4, 2022, similar pattern can be noticed – i.e., EBITDA up by ~5%, while DCF up by ~2%.

Here we can clearly identify the source of this, which is the expanding cost of financing levels that have increased by more than $500 in 2023, translating to a relative change of circa 15%.

The reason for this is not so much related to higher SOFR as that was already largely reflected through ENB’s floating borrowings, but more due to the fact that several refinancings took place over 2023 that triggered debt rollovers at more market-aligned financing levels.

With this in mind, let me now explain three aspects that together have justified my bull thesis on ENB.

First is ENB’s progress and outlook on the CapEx front. During Q4, ENB updated the planned project list with several new initiatives that have now increased the size of the capital program to $24 billion by 2028.

Considering the already funded part, it translates to approximately $6 billion (including the maintenance CapEx) of annual investments until year 2028.

Practically, it means the following:

• The Management has now a clear scope of CapEx projects that provides the luxury of both having the visibility on organic growth channels and making the fresh capital sourcing an easier exercise.
• The project list itself encompasses a diverse set of CapEx plans that will further derisk ENB’s profile (e.g., notable bias to gas transmission, which can be considered the least risky segment here).

Second is the state of leverage that has nicely and consistently dropped from debt to EBITDA of 5.1x in 2021 to 4.1x as of year-end 2023. This is a bit surprising given how active ENB has been in the M&A field and how notable chunks of capital it has allocated into organic growth options.

Looking back at the figures, we can see that there have been multiple factors that have supported the deleveraging process, while ENB has remained quite aggressive on its growth agenda. To name the most critical one (besides organic growth in EBITDA), it is the divestitures of non-core assets at very attractive multiples that have injected fresh capital in ENB’s books, which in turn have enabled the Management to make accretive M&A without impairing the balance sheet.

Based on Pat Murray – Executive Vice President and Chief Financial Officer commentary in the most recent earnings call, we can gain comfort that despite the massive CapEx agenda of $24 billion, ENB will not sacrifice its balance sheet:

Enbridge is fully committed to our leverage guardrails of 4.5 to 5x debt to EBITDA, and we will continue to operate within this range post the utility acquisitions. With the announced sale of Alliance and Aux Sable in 2023, we continue our track record of successfully high-grading our capital and we’ll continue to look for opportunities to recycle assets at attractive multiples.

And as we can see, capital recycling will play an important role in making the growth plans happen in a financially sustainable manner.

In my previous article on ENB, I had concerns over the Company’s ability to facilitate all of the necessary CapEx spending without elevating the financial risk profile above the debt to EBITDA of 5x.

However, there are now really multiple elements that mitigate such risk:

• Since ENB has decreased its debt to EBITDA to 4.1x, it means that there an ample room to assume incremental leverage, while keeping the metrics in the target / conservative range.
• Due to the M&A moves in 2023 and looking at the CapEx list above, ENB has become inherently a more de-risked business, which creates a favorable environment to take more debt. Yet even with these factors in mind, the Management has not decided to increase the ceiling level of target leverage, keeping the business in a conservative territory.
• Since EBITDA and DCF have advanced, the underlying financial capacity also increased accordingly, as the larger absolute amount of incoming cash flows per definition supports larger amounts of debt that can be taken without necessary moving the leverage and coverage metrics. The point of expanding base of cash generation provides a nice segway to my final aspect that has made me bullish on ENB.

Third is ENB’s financial outlook, which effectively confirms the overall stability and predictability of the cash flows, which in turn, can be channeled towards distributions that have grown already 29 years in a row.

Until 2026, ENB is expected to grow its EBITDA of 7-9% and DCF of ~3%. In the recent investor deck, the Management also outlined the post-2026 growth trajectory, which indicates a normalized DCF growth of 5%.

The bottom line

Looking back at 2023, Q4 results and considering the guidance, Enbridge can be easily deemed as a highly attractive income play that is subject to stable and predictable growth. The conservative balance sheet coupled with the capacity stemming from internal cash generation (that is expected to grow) and enticing capital recycling programs makes the funding of $24 billion CapEx program sustainable.

At a price to distributable cash flow (P/DCF) of 6.6x and a forward dividend yield of close to 8%, the Company is a clear buy.