On Friday, May 6, 2022, Canadian midstream giant Enbridge Inc. (NYSE:ENB) announced its first-quarter 2022 earnings results. The market appeared to have fairly high hopes for these results as the company’s stock delivered strong performance despite the overall weakness that we saw elsewhere. The firm’s performance overall certainly did not disappoint as the report was quite strong despite the earnings miss. Enbridge also began work on a few projects that should provide it with some growth potential over the next several quarters, which we have also seen from some companies elsewhere in the industry. Overall, these results show us that Enbridge continues to be a very attractive investment for anyone looking to generate a 5.94% yield.
As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company’s earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Enbridge’s first-quarter 2022 earnings results:
- Enbridge reported an operating cash flow of C$2.939 billion in the first quarter of 2022. This represents a 14.63% increase over the C$2.564 billion that the company reported in the prior-year quarter.
- The company reported an adjusted EBITDA of C$4.424 billion in the reporting period. This represents a substantial 8.27% increase over the C$4.086 billion that the company reported in the year-ago quarter.
- Enbridge placed the East-West Tie Transmission Line into service, which represents one of the firm’s forays into the provision of renewable electricity.
- The company reported a distributable cash flow of C$3.072 billion during the most recent quarter. This compares very favorably to the C$2.761 billion that the company reported in the equivalent quarter of last year.
- Enbridge reported a net income of C$1.927 billion in the first quarter of 2022. This represents a meager 1.42% increase over the C$1.900 billion that the company reported in the first quarter of 2021.
It seems essentially certain that the first thing that anyone reading these highlights will notice is that Enbridge saw essentially every measure of financial performance compared to the prior-year quarter. This is mostly because the company saw higher volumes of both liquids and natural gas moving through its system than in the prior-year quarter. As Enbridge makes its money by charging its customers a fee based on the volume of resources moving through its infrastructure, higher volumes correlate to more money coming into the company. This allows for more money to make its way down to profits and cash flows. The biggest reason for the increases is that Enbridge placed a number of new projects into service designed to handle both liquids and gas. As these projects were not in service during the first quarter of last year, they were obviously unable to contribute their volumes or cash flow to Enbridge’s first-quarter 2021 results.
Enbridge announced a few new projects in the earnings report that should allow it to continue this growth performance going forward. One of these is an expansion to the British Columbia Transmission System that is designed to increase the quantity of natural gas that it can carry by 400 million cubic feet per day. Admittedly, this is a rather long-term project that is not expected to come online before 2026. As such, Enbridge does not have any contracts from its customers to use this new capacity. This is something that the company attempts to do before investing in the construction of new infrastructure because it ensures that the company is not going to spend a great deal of money to construct a project that nobody wants to use. Thus, if it fails to obtain the necessary contracts then it will not even engage in the construction of this project. With that said though, there is growing demand among the company’s customers for more natural gas carrying capacity in that area so it will probably be able to obtain the contracts for this proposed project.
This is just one of the many projects that Enbridge currently has under development that are intended to drive the company’s growth over the next few years. In fact, Enbridge currently has C$10 billion worth of projects under construction that are slated to come online between now and 2025:
One thing that we notice here is that Enbridge is devoting a substantial amount of spending towards renewable energy projects. Enbridge has generally been very active in this area, much more than its American peers. Indeed, I must admit that I was stunned by the amount of time and space that the company devoted to this aspect of its business during the conference call, especially considering that it is, overall, much smaller than the firm’s traditional midstream business. Enbridge is very aggressively trying to grow its renewable business, however. It almost seems that it one days hopes that this unit will be as large as its traditional one, although that will certainly take a while.
The majority of Enbridge’s renewable generation capacity that is under construction consists of offshore wind farms (although most of its currently operating capacity is onshore wind). This is an area in which few companies are aggressively trying to develop. In many “green power” media sources and investment reports, it is generally solar power that receives the most hype. However, as I have discussed in various previous articles (notably this one), offshore wind has a number of advantages over both onshore wind and solar power. The most significant of these is that winds offshore are much more stable than winds onshore, which means that the wind turbines will be turning much more often than the turbines of an onshore wind farm. In addition, an offshore wind farm works at night just like an onshore one, which gives it a significant advantage over solar power. These two factors give this form of renewable power significant advantages over any other.
The use of offshore wind power is incredibly popular in Europe, which is probably due to the proximity of much of the continent to large bodies of water. It should come as no surprise then that Enbridge’s offshore wind projects are located in Europe:
This is somewhat interesting because this gives Enbridge exposure to an area of the world in which it previously had no operations. I have long been a fan of international diversification (as regular readers are well aware) so this is nice to see. Another nice thing here is that Enbridge’s offshore wind farms provide the same contract-driven stable cash flows that we have come to expect from the company’s traditional midstream operations. In this case, these contracts are known as power purchase agreements, which require a power purchaser to buy a specified quantity of power from the wind farm over an extended period. These are necessary for any renewable project to be economically viable because they allow the project to generate steady cash flows, which would otherwise not be possible due to the intermittent nature of renewable power generation. For our purposes though, these contracts provide Enbridge with a steady source of cash flow that ultimately provides a great deal of support for the dividend.
One of my biggest concerns with Enbridge has always been the company’s high debt load. It has been making significant progress at improving this lately but it is still much higher than I like to see. We can see this by looking at the company’s leverage ratio, which is also known as the debt-to-equity ratio. This is a measure that is commonly used by lenders to measure a company’s ability to carry its debt because it essentially tells us how long it would take the company to completely pay off its debt if it were to devote all of its pre-tax cash flow to this task. The company stated that it was on-track to have a leverage ratio of 4.7x by the end of the year, which management appears to be very happy with. In fact, management was so happy with it that they executed the first transactions of their share buyback program during the quarter. However, while this is better than the 5.0x that the company has had in the past, it is still higher than most of its peers. In fact, nearly all of the midstream companies in the industry have been working to get under 4.0x leverage. Admittedly, analysts normally consider anything under 5.0x to be acceptable, I would still prefer to see the company get this down to 4.0x before it starts stock buybacks. This is because a lower ratio allows for more flexibility in the event of a cash flow decline. Although Enbridge does enjoy remarkably stable cash flows, an increased margin of safety would still be nice to see.
One of the biggest reasons why investors purchase shares of Enbridge is because of the high dividend yield that the shares pay out. Indeed, Enbridge’s 5.94% current yield is much higher than many other things in the market. As is always the case though, it is critical that we analyze the company’s ability to afford its dividend. After all, we do not want it to suddenly be forced to end it since a dividend cut would reduce our income and likely cause the stock price to decline. The usual way that we judge a midstream company’s ability to pay its dividend is by looking at its distributable cash flow. This is a non-GAAP ratio that theoretically tells us the amount of cash that is generated by the company’s ordinary operations that is available to be paid to the common shareholders. As stated in the highlights, Enbridge had a distributable cash flow of C$3.072 billion in the first quarter of 2022, which works out to C$1.52 per common share. As Enbridge declared a dividend of C$0.86 per common share, Enbridge has a dividend coverage ratio of 1.77x, which is reasonable. Analysts generally consider anything over 1.20x to be sustainable so Enbridge should most likely be able to continue to reward shareholders for years to come.
In conclusion, Enbridge’s results showed largely what we expected to see. Overall, the company produced some growth but most importantly it still retains the potential to deliver that growth for years to come. The increasing emphasis on renewables is interesting and may have some potential so long as its management does not reject the traditional midstream business. Overall though, the company should prove to be a reliable stalwart in any income investor’s portfolio.