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Morningstar | Best Idea Enbridge Agrees to Acquire EEP for an Additional 9%; Enbridge Remains Deeply Undervalued

Best Idea Enbridge entered into an agreement to acquire the remaining outstanding shares of Enbridge Energy Partners in a deal worth approximately CAD 3.2 billion based on Enbridge’s Sept. 17, 2018, closing price. Under the deal, Enbridge will issue 0.335 shares for each unit of Enbridge Energy Partners, approximating 72 million shares. The increased purchase price represents a 9% increase from the initial proposal in May and a 3% increase to our expectations. We still expect the transaction to close during the fourth quarter.

We don’t see the increased purchase price as a needle mover, and we are maintaining our fair value estimate of $16 on Enbridge Energy Partners based on the new conversion rate. We expect shareholders of Enbridge Energy Partners to benefit from the transaction as they will hold a more undervalued company in Enbridge Inc.

We like the move, as it simplifies the Enbridge family into a single holding. After the Federal Energy Regulatory Commission issued its tax disallowance proposal in March, the master limited partnerships no longer serve the purpose they were created for--capital-raising vehicles for Enbridge.

We consider Enbridge a rare triple threat, boasting a wide moat, an attractive 6% dividend yield, and a cheap valuation. While the market continues to place too much emphasis on the dividend and overlook the impact that the growth portfolio will have on future cash flows and the balance sheet, the time is right for long-term investors to capitalize on the stock's considerable upside while collecting a steady stream of growing income.

Our September 2017 Energy Observer, "Don't Overlook Oil Sands: Falling Costs and More Infrastructure Will Make Canadian Production Globally Competitive," highlights our initial call that we expected Line 3 to obtain regulatory approval.

As a reminder, Enbridge's Line 3 replacement project would restore Line 3 to its initial capacity of 760,000 barrels per day, adding 370 mb/d of new pipeline capacity. Similar to other mainline routes, the Line 3 replacement will be a common-carrier pipeline. The pipeline is expected to originate in Hardisty, Alberta, and connect to the United States in Minnesota, where it will connect to other U.S. pipelines. It will provide additional access to refineries in eastern Canada; Cushing, Oklahoma; the U.S. Midwest; and the U.S. Gulf Coast at an expected cost of $7.5 billion. Shipments on the expanded Line 3 can displace feedstock in eastern Canada, but most important, capitalize on the heavy oil refining capacity in the U.S. Gulf Coast while ensuring stability of crude receipts for Minnesota refineries. Construction has already begun on the Canadian portion of the pipeline expansion, while construction on the Minnesota portion is not expected to begin until early 2019.

As detailed in our May report, "Investors' Concerns Over Enbridge's Dividend Are Overblown," we think Enbridge can meet its targeted annual dividend growth of 10% through 2020. We expect the growth portfolio to generate almost CAD 4 billion in incremental EBITDA, which will support the dividend growth with a healthy distributable cash flow ratio of 1.4 times the forward dividend--more than enough buffer.

Best Idea and 4-star-rated Enbridge remains our top pick in the energy sector. With the shares trading at about $35 (CAD 45), we see 40% upside. We think investors are overlooking Enbridge’s big picture and are too narrowly focused on the company as a dividend stock. Because of this, we think they are overlooking cash flows from the growth portfolio, especially the Line 3 replacement project and the numerous natural gas projects. Combined, we expect these projects to generate CAD 4 billion in incremental EBITDA to fuel dividend growth while improving the balance sheet from current levels. Please refer to our January report, "Best Idea Enbridge Is a Triple Threat," for a deeper dive into the stock's upside.