Plunge in oil prices amid coronavirus scare took a toll on the oil & gas companies around the world. The unmatched demand destruction is certainly not good news. Adding to the pain, the price war between Saudi Arabia and Russia to grab a higher market share further played a villain. Stock prices of oil & gas companies have corrected significantly and rightly so. While the economy will need time to get out of the woods, we believe it’s time to buy some of the fundamentally strong oil companies with a long-term investment horizon. One such stock on our radar is Enbridge Inc.  (TSX: ENB).

Enbridge is a pipeline company, which simply means it transports fuel. The company’s core businesses include Liquids Pipelines (that transports crude oil and other liquid hydrocarbons). 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. Meanwhile, Enbridge, through its Gas Distribution and Storage services, serves nearly 3.8 million retail customers in Ontario and Quebec. Also, the company has a Renewable Power Generation business, generating about 1,750 megawatts (MW) of net renewable power in North America and Europe.

Investment thesis 

• Built to survive and thrive: Similar to its peers, Enbridge stock got a fair amount beating as lower demand for oil means lower volumes for the company. We do acknowledge that this very difficult time for the industry. However, Enbridge’s scale and diversified business ensure steady cash flows. Meanwhile, the company has a top-notch client base, which means Enbridge is built to withstand situations like the one we are in.

The company’s business is resilient as it doesn’t have any direct commodity exposure. The caveat to this is that the company doesn’t benefit when crude prices go up. However, more importantly, no direct exposure to commodity caps the downside amid large swings. 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.

Enbridge has the best and largest customer base. So 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 stellar 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.

Resilient Business (Source: Company Reports)

From the financial stability point, Enbridge sold CAD 8 billion worth of assets that were non-core to its business. The move strengthened its balance sheet and provided the flexibility to invest in future growth.

• Gas distribution and storage business acts as a hedge: Enbridge’s gas distribution business is a little underappreciated one. However, it acts as a hedge amid a tumultuous time like this. The business is fully regulated, ensuring solid, reliable future cash flows even during a tough operating environment. With the Spectra merger, the company’s utility assets have nearly doubled with a significant cost advantage over other fuels. Enbridge Gas is the largest natural gas utility in North America in terms of throughput and serves approximately 12 million people. Notably, the demand for power remains stable and is immune to economic cycles. With strong utility base rate growth and reliable demand, the segment will continue to generate stable cash flows in the future.

Strong Utility Rate Base Growth (Source: Company Reports).

• Steady income flow: Enbridge is a cash cow and has consistently boosted its shareholders’ returns through higher dividends. The company has a long track record of paying dividends. Enbridge has raised its dividends for 25 consecutive years, thanks to the stable cash flows. The company has increased its dividends by about 10% annually over the last three years. In 2019, the company paid dividends worth CAD 5,973 million. With the decrease in the stock price, Enbridge’s dividend yield stands at juicy 8.3%. We don’t see any liquidity crisis for Enbridge. Investors should note that the current pay-out rate is sustainable despite near-term challenges, owing to the company’s low-risk and regulated business which ensures a steady flow of income. Barring short-term headwinds, we expect the company’s distributable cash flow to remain strong in the coming years.

Dividend Growth and TSR (Company Reports)

Financial Highlights:

Enbridge finished 2019 on a strong note with exceptional operating and financial performance. The company posted total revenue of CAD 56.07 billion that increased about 8% on a year-over-year basis. Notably, the company generates revenues from three primary sources that include commodity sales, transportation and other services, and gas distribution. Commodity sales increased about 6% year-over-year to CAD 29.31 billion. Meanwhile, transportation and other services revenues jumped 15% year-over-year to CAD 16.56 billion. Gas distribution sales fell 4% to CAD 4.21 billion.

Adjusted EBITDA increased 3% year-over-year to CAD 13.27 billion. The year-over-year increase in adjusted EBITDA came on the back of strong operating performance and increased asset utilization. By segments, Liquids Pipelines adjusted EBITDA benefited from higher volumes and favorable price differentials. Meanwhile, increased volume throughput on the Bakken Pipeline System further supported the segment’s EBITDA. Gas Transmission and Midstream’s adjusted EBITDA decreased on a year-over-year basis, reflecting business divestiture. Gas Distribution and Storage segment’s adjusted EBITDA remained flat as benefits from higher distribution charges were offset by lower utilization due to the unfavorable weather conditions.

Enbridge posted adjusted earnings of CAD 5.34 billion, up 17% year-over-year. Meanwhile, the distributable cash flow jumped 21% year-over-year to CAD 9.22 billion.

Enbridge ended 2019 with cash and cash equivalents of CAD 648 million, up from CAD 518 million in 2018. The company’s Debt-to-EBITDA (LTM) ratio was 4.5x (within the company’s long-term target of 4.5x to below 5.0x).

Key Financial Highlights (Source: Company Reports)

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%

Top Ten Shareholders (Source: Thomson Reuters)

Key Metrics (Source: Thomson Reuters)

 

Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodology: EV/EBITDA Multiple Approach 

EV/EBITDA Valuation (Source: Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: Enbridge stock has corrected more than 24% so far this year, which presents a good entry point for long-term investors. We have seen an unprecedented decline in oil prices, reflecting demand destruction amid COVID-19 outbreak and price war between Saudi Arabia and Russia. Lower oil price is hurting oil & gas companies across the globe. While challenges persist in the short-term, we expect we oil price to adjust gradually. Notably, oil prices bounced back sharply after US President Donald Trump indicated a truce between Russia and Saudi Arabia on a price war. This could lead to a reduction in oil production and support prices in the short-term. However, with the drastic slide in stock prices of oil & gas companies, it is prudent to put money in fundamentally strong companies like Enbridge, which has diversified business, stable cash flows, and solid balance sheet. We expect Enbridge to withstand the current slowdown and bounce back strongly as the economy returns to normal. Besides, Enbridge is an excellent investment option for investors seeking steady income flow. Enbridge is a Dividend Aristocrat and has consistently raised its dividend in the last 25 years. Enbridge stock currently offers a dividend yield of 8.3%, which looks attractive. We have valued Enbridge stock using EV/EBITDA relative valuation method. Enbridge trades at a premium when compared to peers. However, the company’s premium valuation seems warranted, given the company’s diverse business and stable and predictable cash flows. 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 39.07 per share, up ~1.1% on April 2, 2020.

 

ENB One-Year Daily Price Chart (Source: Thomson Reuters)

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Disclaimer

 

The advice given by Kalkine Canada Advisory Services Inc. and provided on this website is general information only and it does not take into account your investment objectives, financial situation and the particular needs of any particular person. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. The website www.kalkine.ca is published by Kalkine Canada Advisory Services Inc. The link to our Terms & Conditions has been provided please go through them. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations later.