Enbridge: End Of Year Special, Buy Their 7% Yield And Get Any Growth For Free

Summary

The recent broad-based energy sector sell-off has presented very desirable opportunities for investors, such as Enbridge.

They are moving to a self-funded operating model in 2022, which is a game-changer that strengthens their dividend sustainability.

Thankfully this will still happen along with continued growth capital expenditure that sets a solid base for further dividend growth.

It appears that their current share price does not reflect any of their growth prospects with even a conservative intrinsic value over 50% higher.

This gives investors a rare deal to generate significant alpha from a premium quality company and thus I believe that upgrading my rating to very bullish is appropriate.

sefa ozel/E+ via Getty Images Introduction

Whilst the recent broad-based energy sector sell-off can be painful for investors who see their portfolios suddenly lose value, sometimes in just a matter of weeks, they are actually a double-edged sword that also presents very desirable investment opportunities. One such example is Enbridge (NYSE: ENB ) who has seen their share price decline slightly more than 10% in barely over one month, thereby creating an end-of-year special that gives investors a very desirable opportunity to buy their high 7.20% dividend yield and get any growth for free. Background

When it comes to selecting high yield income investments, there are many ways to separate different investments but in my view, the ones that self-fund their dividend payments are far more desirable than their peers who are reliant upon debt-funding. Throughout their recent years they have prioritized investing in growth projects and as a result, their free cash flow has suffered, which has seen their dividend coverage only average a very weak 47.95% during 2018-2020, thereby leaving them reliant upon debt-funding to bridge the gap. Image Source: Author.

Despite this historical reliance upon debt-funding, thankfully their cash flow performance remained resilient despite the severe economic turmoil with their operating cash flow increasing by 4.08% year-on-year to C$9.781b during 2020 versus C$9.398b during 2019. Whilst it may seem rather lackluster that their operating cash flow of C$6.954b during the first nine months of 2021 is down 7.61% year-on-year versus their equivalent result of C$7.527b during 2020, this does not tell the entire story.

If removing the temporary impacts of working capital movements, it shows that their underlying operating cash flow for the first nine months of 2021 was actually C$8.022b and thus well ahead of their equivalent result of C$7.314b during 2020, which represents an increase of 9.68% year-on-year. Whilst their dividend increase for 2022 is only a modest 3%, their guidance still forecasts adjusted EBITDA growth of 9% at the midpoint and thus it stands to reason that their operating cash flow should see comparable growth once again in 2022 given the positive correlation between these two metrics. Even though this alone is already exciting, 2022 also sees a game-changer whereby they finally switch to a self-funded operating model, as the slide included below displays. It can be seen that in 2022 and beyond they are guiding to have approximately C$2b per annum of incremental capacity within their annual investable capacity, which represents the portion of their distributable cash flow after funding their growth capital expenditure and dividend payments. This means that unlike in the past when they were reliant upon debt-funding to bridge the gap, they are now forecasting that their dividend payments will be self-funded in 2022 and beyond. Since they are achieving this whilst still investing in growth projects makes it very realistic to see further dividend growth continue well into the long-term. If any readers are interested in further details regarding their upcoming self-funded operating model and their financial position that remains healthy and supportive, please refer to my previous article since these remain unchanged since publishing. Discounted Cash Flow Valuations

Since they are a midstream company with a high dividend yield, they are mainly sought by income-focused investors and thus their intrinsic value centers upon the income that they can provide their shareholders. This means their intrinsic value can be estimated by utilizing a discounted cash flow valuation that exchanges free cash flow for their dividend payments. If interested, all of the details regarding the inputs utilized for these valuations can be found in the relevant subsequent section.

Since selecting variables for discounted cash flow valuations can be rather difficult and open to small errors as well as manipulation, Monte Carlo Simulations have been provided to illustrate how the odds are stacked in each scenario. There is never a silver bullet […]

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