Enbridge: Vast Upside Potential And Compelling Yield (NYSE:ENB)

Investment thesis

My previous bullish thesis about Enbridge (NYSE:ENB) as of November 28, 2023, aged well. The stock price lagged behind the broader market, but my bet was on safe dividend growth rather than outpacing the broader market in terms of growth. Just a couple of days after my previous thesis went live, the company increased its dividend for FY 2024 by around 3%. This is a bullish sign proving my optimistic opinion about the safety of the dividend. Moreover, 3% growth is higher than the one I have incorporated into my previous valuation analysis. The stock is still very attractively valued and recent developments suggest that the dividend is still safe and a 7.4% forward yield looks like a no-brainer for investors seeking for safe and high yield. All in all, I reiterate my “Strong Buy” rating for Enbridge.

Recent developments

Enbridge released its latest quarterly earnings on February 9, when the company missed consensus estimates. Revenue declined by around 15% on a YoY basis, but the adjusted EPS expanded by one cent.

Energy sector, even midstream, is cyclical and the company’s revenues substantially depend on cycles in the industry. But what is crucial is how flexible a company is to address fluctuations in revenue. Enbridge looks very strong from this perspective. Despite a 15% revenue decline in Q4, Enbridge’s gross margin expanded by almost nine percentage points. This improvement helped to expand the operating income as well, by around 150 basis points. Improved operating leverage resulted in expanding the free cash flow by around $300 million on a YoY basis. Free cash flow is a crucial metrics given the fact that I am betting on the company’s stellar dividend yield’s safety.

Enbridge is very likely to sustain its free cash flow stable over the long-term because the company has an unmatched set of assets including liquids and natural gas pipelines and storage for them, LNG facilities, and renewable energy assets. This diversified portfolio of assets positions Enbridge well to absorb the overall energy demand growth, mitigating the risk of secular shifts in energy consumption patterns.

According to the latest Investor Day presentation, the absolute energy demand is expected to sustain growth over multiple decades ahead. This is a favorable industry trend for Enbridge, one of the largest energy midstream companies in the world. The projected absolute energy demand growth looks sound considering the growing population and trend to more sophisticated digitalization solutions, which require more energy.

Another positive development for Enbridge is that despite all the initiatives to accelerate clean energy transition, North America is firing all cylinders in traditional energy. Both Canada and the U.S. produced record volumes of oil and gas in 2023. Due to the isolation of Russian oil after sanctions, North America now has more potential to export its energy commodities to Europe. As a result, Enbridge’s CEO forecasts Canadian pipelines to achieve maximum utilization and run out of spare capacity within the next 3-4 years. This is a big tailwind for Enbridge to improve its leadership in the North American midstream business.

As a result, the management expects substantial CAPEX in the next several years to expand infrastructure which will be able to meet the highly likely demand growth. The recent formation of a JV with WhiteWater/I Squared Capital and MPLX (MPLX) aligns with the strategy to expand presence in Permian Basin with additional pipelines and storage assets to address growing liquefied natural gas and U.S. Gulf Coast demand.

Despite risks of investing in large expansion projects, I have high confidence that Enbridge will likely convert this massive capex into long-term success. Firstly, Enbridge has a healthy balance sheet with moderate leverage, which provides the company with vast financial flexibility to fund its substantial CAPEX. Secondly, the company’s capital allocation and investment framework look flawless to me as ENB has been successfully balancing between expanding its capacity, revenue growth, and increasing dividends over decades.

Valuation update

The share price declined by around 3% over the last twelve months and by 1% year-to-date. ENB is currently at the midpoint of the last 52 weeks’ share price range. The stock looks very cheap when I compare the current P/E and Price/Cash Flow ratios to ENB’s historical averages. Since ENB is a dividend superstar to me, I consider these two ratios as by far the most important when we speak about this stock’s valuation.

I am simulating the dividend discount model [DDM] to get more conviction about ENB’s undervaluation. Despite the latest 3% dividend increase, I reiterate my 2% long-term CAGR to be on a safe side. I adjust down my previous WACC by 75 basis points, which aligns with expected three rate cuts in 2024. I also update the current dividend payout with an FY 2025 $2.78 consensus projection. I am using FY 2025 estimate because I am calculating target price for the next 12 months.

According to my DDM simulation, Enbridge’s fair share price is almost $53. This indicates a 49% upside potential, which means that the current share price is compelling. Please also do not forget a massive 7.4% forward dividend yield.

Risks update

The energy midstream industry is not a megatrend like AI or cloud. This means that the industry will highly unlikely compound with massive CAGR ever again. The industry is mature and my bullish thesis is based on Enbridge’s robust strategic positioning within the industry with its unmatched midstream infrastructure. However, the industry itself is not expected to grow rapidly. Therefore, investors seeking for exponential returns from a stock will highly likely be disappointed to find out that Enbridge is about steady growth.

The business is highly capital-intensive, meaning heavy reliance on debt financing to expand capacity. The current monetary policies in U.S. and Canada are tight and there is little uncertainty regarding the pace of returning interest rates closer to zero. Tight monetary policy limits Enbridge’s financial flexibility which might be an adverse factor if rates stay higher for longer.

Despite expanding its presence in renewable energy, Enbridge is likely to be perceived as a traditional energy midstream company. This means that the company’s performance might be disrupted by initiatives from ecology activists, who are gaining more influence as political leaders in North America tend to support accelerating transition to cleaner energy. For example, just a couple of weeks ago, there was a discussion about Enbridge’s pipeline’s potentially having an adverse ecological impact on Great Lakes. In case ecology activists succeed in their goals to shut down any of the company’s pipelines through governmental decisions, this might be a substantial disruption to Enbridge’s financial performance.

Bottom line

To conclude, Enbridge is still a “Strong Buy”. The stock is around 50% undervalued and offers a 7.4% forward dividend yield. Given the company’s strong fundamentals I consider the dividend to be safe and poised to grow at least in line with the Fed’s long-term inflation targets.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.