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Morningstar | Best Idea Enbridge: Line 3 Delayed, but Our Long-Term Thesis Remains Intact

Best Idea Enbridge has announced that the Line 3 replacement project will be delayed until the second half of 2020, a year later than management’s previous timeline. The delay comes as a little surprise to us--we previously expected the project to be placed into service during the first half of 2020. Minnesota announced that its permitting process won’t be completed until November of this year, which is five months later than the company’s estimates. After the state permits are received, Enbridge expects to receive the federal permits 30-60 days later.

As a result, we now expect the project to be placed into service during the fourth quarter of 2020. Accordingly, we are lowering our 2020 EBITDA forecast from CAD 14.6 billion to CAD 14.1 billion, both of which are below management’s previously announced target. However, we think that the 2020 10% target dividend growth remains safe, and we are lowering our distributable cash flow coverage forecast only slightly from 1.65 times to 1.6 times, which represents a comfortable level.

Despite the delayed project and lower 2020 forecasts, our long-term forecasts remain intact. We still expect Line 3 to add significant cash flow to the company’s operations over the long term. Accordingly, we are maintaining our $47 (CAD 62) fair value estimate. The stock is down almost 6% on the news, but we see it as an overreaction. The sell-off presents an attractive entry point or an opportunity for current investors to add to their position, as we still see over 30% upside in the stock paired with a 6.3% (and growing) dividend yield.

Furthermore, we are maintaining our wide moat rating.

Enbridge remains one of our top picks in the energy sector. We think that investors are mistakenly worried about underutilization of the Mainline while competing pipelines are placed into service. Even if the KXL and TMX are placed into service (as we forecast), we expect only minor underutilization of the Mainline until Canadian crude supply ramps up to our forecast levels. We expect all the major pipeline expansions to be operating near full capacity within the next decade.

Investors are also overlooking Enbridge’s big picture and are too narrowly focused on the company as a dividend stock. Because of this, we think they are not focused enough on cash flows from the growth portfolio. Enbridge sports CAD 18 billion of near-term commercially secured capital projects in its growth portfolio, highlighted by the Line 3 replacement project. Once placed into service, we expect the Line 3 replacement project coupled with various natural gas growth projects to generate almost CAD 3 billion of incremental EBITDA, supporting dividend growth.

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 2020 after the announcement of the revised timeline.

Please refer to our January report, "Best Idea Enbridge Is a Triple Threat," for a deeper dive into the stock's upside.

For a detailed look into Canadian crude market and pipeline trends, please refer to our January Energy Observer, "Pipelines Are Canada’s Lifelines.