Enbridge Inc. (ENB) is a Calgary, Canada-based energy infrastructure company with business platforms that include a network of crude oil, liquids, and natural gas pipelines, regulated natural gas distribution utilities and renewable power generation. The company boasts of transporting about 25% of the crude oil produced in North America. Besides transporting crude oil, Enbridge, through its Gas Transmission and Midstream segment, transports about 20% of the natural gas consumed in the US.

Segment Overview

Enbridge’s area of operations is divided into five segments: a) energy services (FY19, 58.1% of total revenue), liquid pipelines (20.2%), gas transmission & midstream (10.3%), gas distribution (10.2%) and renewable power generation (1.12%), respectively.

Key drivers to growth

• Reaffirmed Financial Guidance: For the year 2020, the Company has reaffirmed its financial guidance range of Distributable Cash Flow per Share of $4.50 to $4.80 per share. Despite a near-term reduction in Mainline volumes (which accounts for 30% of EBITDA), the group is confident of achieving the original guidance owing to the strength and stability of its diversified business portfolio.

• Best in class clientele: Even when the North American oil and gas producers are going through a rough patch, most of its customers have rock-solid balance sheets. Here, we are talking about companies like Exxon, BP, Suncor, and Flint, to name a few. The majority of the company’s volumes come from these large companies which have investment grade balance sheets. On the gas transmission side, Enbridge has Eversource, BP, Nextera, CFE, among others. In totality, Enbridge’s 94% of the customers have an investment-grade balance sheet. The number is higher in the case of liquids (about 97%). Notably, most of the producers also have integrated business, which means they are hedging with refining margin at the time of low prices. Further, the company’s liquids contracts are of long-term, typically of 10 to 20 years, which ensures stability. The company has successfully managed to drive EBITDA despite commodity price collapse in the past as well.

• CAD 10 billion growth capital program execution in the next 3-years (2020-22): The group remain focused on the execution of its CAD 10 billion secured capital programme between 2020-22. The company has invested almost half of the planned expenditure,and ~CAD 5.5bn is yet to be utilised. These investments are expected to drive the business growth over the near to medium term. 

• Cost reduction measures in FY20: To weather the COVID-19 impact, the company has considered several cost reductions measures to reduce FY20 costs by approximately CAD 300 million. The primary areas where the group wants to cut down includes outside services and supply chain costs, company-wide salary rollbacks and a voluntary workforce reductions program. 

• Resilient business model: The company’s business is resilient as it does not have any direct commodity exposure. The caveat to this is that the company does not benefit when crude prices go up. With no direct exposure to commodity, it helps to minimise downside risk uncertainities. The company’s business is tightly structured, thanks to the diverse set of businesses, including liquids, natural gas, utilities, and power. We see compelling value owing to the stability and predictability of the cash flows.

COVID-19 impact

The company’s Liquids Mainline system operates at full or near to full capacity. Consequently, the group generates highly predictable cashflows through various cycles. The group is witnessing some impact as through put was down in April. To be precise, it declined 400 thousand barrel per day against the first quarter average of 2.84 million barrels per day. The decline was on account of a rapid decline in gasoline and jet fuel consumption driven by COVID-19. The group believes the slowdown to persist in the second quarter as well. However, the volume is expected to recover in the second half of the FY20, as Coronavirus related travel restriction is expected to cool down, and mobility will recover gradually in North America. Also, when the situation turns favourable, refineries operating in its core Mainline markets will register steep recovery and will come back of previous levels.

Historical Financial Highlights

 Source: Refinitiv (Thomson Reuters)

Q1FY20 Results Highlights

As on May 07^th, 2020, the company reported its interim financial results for the quarter ended on March 31^st, 2020.

Source: Company Reports (Q1FY20) 

• In the Q1FY20, the group’s performance was moderate, given the warmer than normal weather and lower contribution from energy services. However, a strong utilization of the Texas Eastern gas transmission system and a record volume on the liquid mainline drove the financial performance above the management’s expectation. Higher synergy capture within the company’s gas distribution and storage business further supported the financials. 

• Adjusted Earnings were slightly better than the corresponding previous quarter at CAD 1.67bn vs CAD 1.64bn in Q1FY19. This reflects an increase of CAD 28 million or per-share increase of CAD 0.02, primarily led by a reduction in earnings attributable to non-controlling interests, and a lower current income taxes for the quarter. However, earnings were impacted due to surge in depreciation and interest expenses.
   

• The company reaffirmed the financial guidance range for FY20, Distributable Cash Flow per Share of CAD 4.50 to CAD 4.80/share, on account of costs reduction measures taken by the group and given the diversified cash flow pockets of the company. 

• Cash flow from operation during the quarter under consideration recorded a surge of 29% to CAD 2.81 billion against CAD 2.17 billion reported in the same period of the last financial year. Further, the operating costs reduced by CAD 300 million. To manage the cost, the company decided to cut down the compensation of Board and senior management. 

• The group is planning to offload its stake in three wind projects in France. For this, the group negotiated an agreement with Canada Pension Plan Investment Board (CPP Investments). CPP Investments will be owning 49% stake in such Group's projects. The Group is expected to realize $100 million upfront, and pro-rata contributions for development and construction later. 

• The group recorded few one-off items during the quarter (a non-cash impairment of $1,736 million on the company's investment in DCP Midstream and $1,956 million of non-cash unrealized derivative fair value losses). These led to a a GAAP loss of CAD 1.4bn in Q1FY20. 

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 22.3% of the total shareholding. Capital International Investors is the entity holding maximum shares in the company at 6.3%. The Vanguard Group is the second-largest shareholder, with a holding of 3.1% 

Share price performance & technical summary

1-year price chart (as on May 07^th, 2020 after the market close). Source: Refinitiv (Thomson Reuters)

Shares of ENB have traded ~9.47% lower in a year-over period. In a year-over period, ENB shares have tested a 52-week high of CAD 57.2 and a 52-week low of CAD 34.97, respectively and at the last closing price of CAD 44.62, its shares traded approximately 33% above its 52-week low price level and 22% below its 52-week high price level, which reflects that at the current price level the stock is more tilted towards its 52-week high price level, which is a positive trend given the bloodbath in oil market recently.

Further, ENB's shares have recorded a reversal trend on the daily price chart; as after testing a bottom of CAD 33.0 on March 18^th, 2020, its shares have recovered approximately 33%. Also, in the last 5-trading session and a month over the period, its shares are showing a positive price return of 4.6% and 13.3% respectively and outperformed the benchmark index and sector in the same period.

Moreover, its shares started trading above short-term support levels of 50-day, 30-day, 20-day, 10-day and 5-day moving averages, which is a positive indicator. Also, 14-day and 9-day Relative Strength Index is hovering in neutral territory, and more tilted towards the overbought zone, which reflects buying interest are increasing in this counter.

Valuation Methodology (Illustrative): EV/EBITDA

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters).

Stock Recommendation: Given the resilient and diversified business model of the company, its shares have held strong ground on TSX amid a bloodbath in the global financial market and especially in the oil market. A demand plunge for gasoline and jet fuels is likely to weigh on the group's performance in the near term, but other business segments are likely to offset the impact. Further, demand is expected to pick up in second half of the FY20 as global economies are gradually reopening after a lockdown led by the outbreak of COVID-19, increase mobility and lifting on travel restriction would bring back demand in the company's liquid mainline segment. The stock is offering a dividend yield of ~7.4%, which is attractive amid a low interest rate environment. Also, the current price trend is showing potential positive movement in the stock as MACD line is rising, with the difference between 12-day EMA and 26-day EMA is positive. We have valued Enbridge stock using EV/EBITDA relative valuation method. Enbridge trades at a decent level and its valuation seems warranted, given the company’s diverse business and stable and predictable cash flows.The stock is currently trading at a forward EV/EBITDA multiple of ~12x. We expect Enbridge’s multiple to expand as the market recovers. We have arrived at a target price with upside in lower double-digit (in percentage terms). Hence, we give a “Buy” recommendation on ENB stock at the closing market price of CAD 44.62 per share on May 7, 2020. 

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