Enbridge: Buy? Sell? Hold?

Aside from the banks, I’ll bet there’s not a more widely held stock in all of Canada than Enbridge Inc (TO:ENB). And for good reason.

When the dividend is considered, save for a spell in the early ‘90s, nobody that’s ever owned this stock for at least five years has ever lost money.

Even better, literally nobody who has ever owned Enbridge shares for more than 10 years has had a losing position.

The worst anyone has ever done by simply buying and holding Enbridge for a decade is earn a 68% return.

The worst!

That dubious (not dubious) distinction went to the poor sole that purchased Enbridge on Sept. 25, 1985, and held through to Sept. 25, 1995.

When it comes to investing, Enbridge has historically been about as sure-a-thing as there ever was.

Problem is, if you’d bought Enbridge in early-2017 or even through portions of 2016, you very likely have a very different view of this company.

In fact, you might be wondering what on earth is going on given the way the stock has performed.

The stock has rallied rather significantly in recent weeks but at $46-ish remains well off its high of $63 that was achieved back in April 2015, more than three years ago.

Question is: Is there more rally ahead to provide those who bought at that all-time high the 5-year positive return they absolutely should have expected?

Let’s consider!

How we got here?

Given it’s so widely held, Enbridge’s plight of late is well known and has been well documented.

Briefly, it really boils down to perceived financial risk. The company has a lot of debt and has ambitions to add more – a bunch more – to fuel its growth in the years ahead.

Even though this formula has been put to good use over the course of Enbridge’s more than 42 years as a public company, Mr. Market decided to give a thumbs down to this approach in this most recent iteration.

Full disclosure, we shared the market’s concern within our Stock Advisor Canada members-only advisory service. Our Enbridge allocation came after successfully recommending Spectra Energy (F:SEP), but after living with it for a stretch, we suggested members reduce this exposure in December 2017.

Good timing, as the stock went on a precipitous slide thereafter. Falling from about $50 to $38 or so.

In recent months, however, as indicated, Enbridge has gotten its groove back, so to speak.

Through a series of corporate actions, Enbridge’s management has skillfully been able to push much of the market’s perceived risks to the side.

Assets have been sold, helping to alleviate financial risk. The corporate structure has been simplified. And a regulatory decision to allow the replacement of the company’s Line 3 pipeline that carries crude oil from Alberta to the U.S. Midwest fell in the Enbridge’s favour.

Essentially, what appeared to be a situation that was spiralling out of control has found its footing and appears ready to continue its march forward. Maintaining its near impeccable record of delivering outsized shareholder returns to those willing to hold the stock for a minimum of five years.

Not so fast

All right, all right. Let’s pump the brakes a bit here.

On the surface, we’re looking at a company that sports a generous dividend yield of 5.7% that trades below its long-term average on several multiples.

Enbridge is arguably cheap. But…

I continue to get bungled up in one dynamic that nobody else seems to care much about.

You know that aforementioned dividend? And the juicy 5.7% yield. Well, Enbridge can’t afford it!

Actually, that’s not entirely true.

By traditional means, that is, free cash flow (cash from operations minus capital expenditures), Enbridge can’t afford its dividend and the $22 billion is still plans to spend on new projects in the years ahead.

Check it out.

During the last 12 months, Enbridge reported cash from operations of $8 billion.

Capital expenditures were…$8.3 billion.

Which means, free cash flow, which is the cash available to pay the dividend, was negative $300 million.

Yet, dividends paid on the common stock alone were $2.7 billion.

By my math, Enbridge was about $3 billion short when it comes to covering its dividend over the past 12 months. I’ve watched enough mafia movies to know, this isn’t a sustainable situation.

But wait. This was just an anomaly, right?

Think again.

The table below outlines the cumulative figures over the past five fiscal years (2013 – 2017) for each of the metrics mentioned (in millions):

Source: S&P Global Market Intelligence

Rub your eyes. Give your head a shake. Whatever. Those numbers are real. And big!

Over the last five fiscal years, Enbridge came up short covering its dividend to the tune of a whopping $23.4 billion!!

No wonder Mr. Market was getting concerned.

Especially given the company has committed to continually raising that unaffordable dividend in the years ahead.

So how on earth then, you ask, did the company cover this obligation?

Well, Enbridge’s total debt has grown from $26.4 billion in 2013 to $66.7 billion at last count.

And over those five fiscal years, $5.0 billion of common stock has been issued and $4 billion of preferred stock.

Essentially, Enbridge has been reliant on the kindness of strangers to exist as it has. And for the past couple years or so, those strangers have been rather ornery, more or less dictating/demanding the corporate actions referred to earlier.

So: Buy? Sell? Or hold?

To be sure, Enbridge is not alone when it comes to applying this formula. It’s a formula that’s used by and works for many.

And if there’s one take-away from any of this, it should be that even though Enbridge and many of its peers dress-up as highly stable pipeline companies, in reality they’re in the financial business. Like a bank, Enbridge raises money at one rate (deposits) and invests it at another (loans), picking up the spread along the way.

Confidence from market participants is required to ensure the spread between those rates is as wide as possible. That confidence wavered, thus impacting Enbridge’s spread game along the way.

Where I wash out then, and this is a personal opinion, is first and foremost, be aware that you’re not really investing into a pipeline company when you own shares of Enbridge. You’re investing in a financial beast that’s dependant on the kindness of strangers and the capital markets, both debt and equity.

If the financial crisis taught us anything it’s that things like “faith,” “trust” and “kindness” can evaporate in the blink of an eye. That is, Enbridge’s game could literally come to a screeching halt with little more than a moderate breeze.

Given Enbridge’s popularity amongst Canadian investors, I don’t think this is a very well understood scenario when it comes to owning this stock.

And it’s with this scenario in mind that I suggest the following (all my opinion):

• If you don’t own Enbridge, even though it has its warts, there’s reason to at least begin building a position at current levels. Depending on the make-up of your portfolio, you could buy with a target allocation of perhaps 2-3% in mind.
• It’s the people that own Enbridge with more than a 3% allocation that give me the greatest concern. If this is you, I suggest selling shares to bring it back to that level.
• If you own Enbridge, with a 2-3% allocation, you’re probably OK to continue to hold.

Foolish Bottom Line

The answer then, as is so often the case in the investing world, is not as cut and dry as to say “Buy” “Sell” or “Hold.” Depending on your personal circumstances, all three apply and are entirely reasonable.

As for our exposure within Stock Advisor Canada (a service that I head up, by the way), we’ve rated Enbridge as a “Hold” as it fits with this allocation and will continue to do so.

Frankly, though, there are a whole pile of other companies we’d “Buy” ahead of this one.

Heck, our most recent Canadian recommendation was the company that Enbridge just sold some rather prized energy assets to as it continues to try and appease its market overlords.

Iain Butler,
CFA Chief Investment Advisor,
Motley Fool Canada