When a company's stock drops sharply but its dividend rises – and is expected to continue rising – I get interested as an investor.
Shares of pipeline operator Enbridge Inc. have suffered an extraordinary drubbing this year. The stock, which closed Tuesday at $41.86, is down about 37 per cent from its April high of $66.14, with nearly one-quarter of that drop coming in December.
Plunging oil prices are the main culprit, as investors worry that reduced investment by producers could throw a wrench into Enbridge's long-term growth plans. Fears that interest rates will rise are also hurting the stock.
Adding to the gloom, the collapse in shares of Kinder Morgan Inc. – a U.S. pipeline operator that cut its dividend by 75 per cent on Tuesday – has cast a pall over the entire sector.
But as a long-term investor focused on dividend growth, I'm not giving up on Enbridge. Quite the opposite: With the shares now yielding 5.1 per cent – up from 3.1 per cent at the start of 2015 – I'm using some of the cash in my Strategy Lab model dividend portfolio to purchase an additional 10 shares (view my model portfolio online).
I also recently added to my Enbridge position personally. Here's why:
The dividend keeps growing
On Dec. 3, Enbridge raised its dividend by 14 per cent to an annualized $2.12 a share – extending its growth streak to 21 years. More increases are expected: Enbridge aims to raise its dividend by 14 to 16 per cent annually through 2019, driven by $25-billion of "secured" projects and another $13-billion in "highly probable" ones. If Enbridge were to hit even the low end of its guidance range, the dividend would climb to $3.14 by 2019 – equivalent to a yield of 7.5 per cent based on the current share price.
The dividend is well-covered
Enbridge's dividend is secure. On the 2016 guidance call, president and chief executive Al Monaco said the company generates about twice as much ACFFO (available cash flow from operations) as it pays in dividends.
This excess cash gives the company a "buffer" as it executes its growth projects and "allows us the flexibility to capitalize on new opportunities and, depending on how we see those opportunities, whether they're attractive or not, it provides scope to accelerate the pace of dividend growth," Mr. Monaco said.
Commodity exposure is limited
Unlike an oil and gas producer, Enbridge is basically a toll collector that has minimal direct exposure to energy prices. According to the company, just 3 per cent of its earnings are directly "at risk" from commodity prices. What's more, the vast majority of its earnings are either regulated or secured by long-term contracts with financially strong companies. That stability allows Enbridge to forecast its earnings out several years: From 2015 through 2019, it expects ACFFO to grow at an annual rate of 15 to 18 per cent, supported by pipeline expansions, higher shipping volumes and investments in non-core areas such as renewable energy.
Analysts see no signs that low energy prices will dent Enbridge's earnings any time soon. "Enbridge's growth outlook remains intact through 2019 ... even in the current depressed commodity environment," CIBC World Markets analyst Paul Lechem said in a note following Enbridge's investor day in October.
Enbridge is not Kinder Morgan
If you think Enbridge's stock has taken a beating, it's gotten off lightly compared with Kinder Morgan, which is down 36 per cent in just the last nine days and 63 per cent this year. Following the company's recent agreement to increase its stake in troubled Natural Gas Pipeline Company of America to 50 per cent from 20 per cent – which will add about $1.5-billion (U.S.) to Kinder Morgan's debt – Moody's had changed Kinder Morgan's credit outlook to negative, raising the possibility of a downgrade to junk status. To protect its investment grade rating and fund its expansion program, Kinder Morgan on Tuesday slashed its dividend by 75 per cent, prompting Moody's to remove its negative rating.
Enbridge is a different story. Its investment-grade credit ratings are stable and the dividend is expected to climb at double-digit rates for the next four years – perhaps longer. "I don't see any chance of a dividend cut, you can quote me on that," said analyst Darryl McCoubrey of Veritas Investment Research. However, without a rebound in oil prices to spur more production, there is a risk that Enbridge might not be able to achieve the "robust guidance they've given toward their cash flow and dividend growth. If commodity markets don't improve, I certainly don't think [achieving its guidance] is a slam dunk," he said.
Closing thoughts
Doubts surrounding Enbridge's ability to deliver on its growth targets are a key factor in the stock's decline. But the drop has been so extreme that, even taking such risks into account, some investors see a buying opportunity.
"It isn't often that, with such a financially sound company, you get this ... level of divergence between a rising dividend and a declining share price," said Robert Cable, an investment adviser with ScotiaMcLeod who owns Enbridge shares personally and for clients.
It's anyone's guess what the share price will do in the short run, but if Enbridge can keep its cash flow and dividend growing at a healthy clip, over the long run investors stand to be rewarded.
Yield Hog is part of Globe Unlimited's Strategy Lab series. Subscribers can read more at tgam.ca/strategy-lab