I am neutral on energy company Enbridge (ENB). It has many projects heading into the next decade, but due to regulatory concerns and current cash flows, I reiterate a Hold rating.
Company Overview
Energy infrastructure company Enbridge operates through the following segments: Liquids Pipelines, Gas Transmission & Midstream, Renewable Power Generation, Gas Distribution & Storage, and Energy Services.
The company operates in Canada and the U.S.
Future Outlook
Enbridge reconstructed portions of its Line 3 by replacing 34-inch pipe with 36 inches to expand its capacity. Enbridge concluded its reconstruction in October 2021.
In February 2020, the company entered an agreement to acquire Rio Bravo Pipeline Company from NextDecade for a cash purchase price not-to-exceed $25 million. In another program, called the Spruce Ridge Program, the company added two sections of pipeline to existing facilities on the natural gas transmission system in northeastern British Columbia.
Enbridge is quickly growing its infrastructure and developing new sources of revenue. While these projects require heavy capital expenditures, the company has built its revenues consistently from C$33.8 billion in 2016 to C$50 billion in 2020 before taking a hit from the pandemic. Enbridge revenues are nearing pre-pandemic levels.
The company has enough projects concluding in the following years to anticipate consistent free cash flow growth. With a clear plan over the next decade to improve and implement new infrastructure, Enbridge is growing quickly.
Company Financials
The company’s balance sheet and income statement are stressed by its continued projects. Currently, Enbridge has fewer short-term assets than it does short-term liabilities. While revenues climb, its operational expenses have remained flat, instilling confidence that Enbridge will improve its balance sheet over the following quarters.
Cash flows have varied over the years with its infrastructure projects and improvements. As its projects conclude, investors may see an improvement in cash flow with a slight increase in margins by approximately 1.5% compared to 2021.
The company’s price-to-earnings ratio is 20x, which is high compared to the overall market of around 13x. Enbridge also has a lot of debt, at a 144% debt-to-equity ratio. Again, higher debt levels are expected with the infrastructure improvements, but it is still concerning.
The company’s debt is not covered well by operating cash flow, as its annualized OCF is only 12% of total debt. However, the interest on debt is well covered by operating earnings at 3x coverage.
Enbridge is feathering the throttle with its capital expenditures. With future increases in earnings, the financial picture is likely to improve. The company faces regulatory risks moving forward, but it is diversifying revenue sources effectively.
Valuation
My discounted cash flow analysis assumes free cash flows in 2022 started around $1.163 billion. Based on the current growth opportunities, the cash flows could grow at 10.8% annually. Cash flows are discounted at Enbridge’s weighted average cost of capital of 5.8%.
Starting with $1.163 billion in free cash flow and growing at 10.8% annually, then discounting future cash flows by 5.8%, Enbridge’s present value of cash flows in addition to its net long-term assets assumes a value of around $43.00 per share.
Risks
Enbridge faces regulatory risks surrounding Line 5 that travels through the Great Lakes into Michigan. The company must conduct an environmental impact study to replace an almost 70-year-old line. The study could delay the reconstruction by years. Even then, there is heavy advocacy to shut down the line altogether.
While a possible Dakota Pipeline shutdown could affect Enbridge in the near term, it is likely to experience a net gain because its other Bakken oil pipelines could absorb displaced barrels. The gain could be as much as $39 million in EBITDA by rough estimate.
Wall Street’s Take
Turning to Wall Street, Enbridge has a Moderate Buy consensus rating, based on five Buys, six Holds, and no Sells assigned in the last three months. At $45.75, the average Enbridge price target implies 0.3% downside potential.
Final Thoughts
Enbridge is a growing contender in the energy infrastructure business and has a strong market presence in North America. Given the current regulatory climate, the company faces headwinds but will likely continue its growth.
Based on the current valuation, I reiterate a Hold rating as there is not enough value and too much regulatory risk to warrant a Buy rating.
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