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Morningstar | Best Idea Enbridge Announces 10% Dividend Hike; Shares Remain Deeply Undervalued. See Updated Analyst Note from 11 Dec 2018

Best Idea and wide-moat Enbridge held its 2018 investor day and announced a 10% dividend increase, as expected. On an annualized basis, the 2019 dividend stands at CAD 2.95 per share, representing a 6.9% yield. Many investors feared that Enbridge wouldn’t be able to meet its targeted increase, but we feel comfortable that the company can make its payments with its distributable cash flow coverage of 1.65 times the dividend payments.

Enbridge also announced 2019 guidance that included adjusted EBITDA of CAD 13 billion and distributable cash flow of CAD 8.9 billion. Both targets are in line with our expectations. The company continues to expect Line 3 to be placed into service in the back half of 2019, slightly ahead of our first-quarter 2020 expectations. Construction is 80% complete in Canada, and Enbridge expects it to be fully completed by July 2019. Enbridge is also continuing its negotiations on the Mainline tolling agreement but did not give a detailed update due to ongoing discussions with shippers. As a reminder, the current agreement expires in 2021, but Enbridge is using the current uncertainty associated with future egress to lock in future cash flows on the Mainline.

We are maintaining our $47 (CAD 64) fair value estimate and wide moat rating. Our long-term thesis remains intact, and we see tremendous upside in the stock. We expect Enbridge to easily meet its 10% average annual dividend growth target through 2020 while maintain a healthy distributable cash flow. We consider Enbridge a rare triple threat, boasting a wide moat, an attractive 6.9% dividend yield, and a cheap valuation. We think 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 1.3 times the forward dividend--more than enough buffer.

Enbridge remains our top pick in the energy sector. With the shares trading at about $31 (CAD 42), we see 50% 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.