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Morningstar | Solid Quarter for Best Idea Enbridge; Raising Our Dividend Outlook

Wide-moat and Best Idea Enbridge reported a strong quarter that generally came in slightly below our optimistic expectations. The company reported fourth-quarter adjusted EBITDA of CAD 3.3 billion, or CAD 1.84 per share, compared with CAD 3 billion, or CAD 1.79 per share, in the year-ago quarter. Enbridge also reported distributable cash flow of CAD 1.9 billion compared with CAD 1.7 billion in the fourth quarter of 2017. The lower-than-expected performance was driven by a slower ramp up of natural gas growth projects.

The company reported record quarterly volumes, averaging 2.83 mbbl/d on the Lakehead system, which represents 99% utilization, and 2.69 mbbl/d on the Canadian Mainline. With the Mainline operating near full capacity, Enbridge continues to advance its priority access contracts for the system. The proposal would change the contract structure to 90% take-or-pay commitments with 10% spot capacity. The company is only pursuing this option currently and is optimistic on its chances.

During the quarter, Enbridge announced CAD 1.8 billion in capital growth projects, including the Gray Oak crude pipeline in the Permian basin. Subsequent to the quarter-end, the company announced another CAD 0.3 billion of secured growth projects. With these new projects, we are increasing our dividend growth outlook for 2021 and beyond to 3% annual growth from 2% annual growth. Despite the increase, we still management’s target of 5%-7% as aggressive unless major growth projects are added to the portfolio.

We are maintaining our $47 (CAD 62) fair value estimates and wide moat rating. The stock is up modestly on the earnings report, and we still see 30% upside in the stock. We think that investors are mistakenly worried about underutilization of the Mainline while competing pipelines are placed into service. We expect only minor underutilization of the Mainline until Canadian crude supply ramps up to our forecast levels.

Accordingly, we expect Enbridge to generate significant free cash flow, allowing the company to increase its dividend at approximately 10% in 2020 and 3% thereafter. After its recent 10% dividend increase, the stock is currently yielding 6.1%. For a deeper look into Enbridge’s dividend, please refer to our May report, "Investors' Concerns Over Enbridge's Dividend Are Overblown."

Enbridge continues to improve its balance sheet, with adjusted leverage levels falling to 4.7 times, which exceeded our expectations. The company also achieved its target of decreasing leverage below 5 times by the end of the year. Accordingly, Enbridge suspended the dividend reinvestment program, effective Dec. 1, as additional funding sources are no longer needed to support the strategic plan. The rating agencies have taken notice, and Moody’s upgraded Enbridge’s credit rating to Baa2 from Baa3, while assigning the company a positive outlook.

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.”