Enbridge (ENB) is an energy infrastructure company that operates a network of pipelines and renewable energy projects.
Investors who are looking for oil stocks should perhaps consider Enbridge, as it provides less cyclical exposure to the industry. We are neutral on the stock.
Competitive Advantage
Instead of drilling and producing oil and natural gas, the company has contracts with companies to transport the fuels instead through its network of pipelines. This is where Enbridge’s competitive advantage lies. In order to reproduce its network of pipelines, it would likely cost over $100 billion if we use Enbridge’s balance sheet as an estimate of the cost.
It is a very capital-intensive business that creates a high barrier to entry. In addition to the cost, there are many regulatory hurdles that would need to be overcome. This has allowed the company to build up an impressive book of business.
Enbridge transports 20% of the natural gas consumed in the U.S. and 25% of North America’s crude oil. What makes the firm less cyclical than oil producers is that it has take-or-pay and cost-of-service contracts with customers.
Take-or-pay means that customers such as oil producers must pay a minimum fee to Enbridge even if they don’t use its pipelines. Cost-of-service means that customers have to cover Enbridge’s costs plus its desired markup. This helped reduce the impact of the oil crash in 2020. As a result, Enbridge is able to enjoy stable and predictable cash flows.
Risks
The main risk we see in Enbridge is debt. It has a little more than $56 billion worth which translates to a debt-to-EBITDA ratio of 6.1x. This is currently not a problem because its interest coverage ratio is 3x (measured as EBIT divided by interest payments).
However, the company has a high dividend yield, which it wouldn’t want to cut. As a result, the company will continue to have to rely on debt financing portions of its growth projects. This isn’t a problem in low-interest-rate environments, but it may become a problem if central banks are forced to raise rates faster than they want to.
In such a situation, the company would have to choose between cutting the dividend or delaying growth projects. Both scenarios would be unwelcomed by investors, causing downward pressure on the stock.
However, 80% of Enbridge’s EBITDA has inflation protections in place. Since inflation is the catalyst for rising rates, this clause in its contracts will help boost earnings and mitigate the impact.
Wall Street’s Take
Turning to Wall Street, Enbridge has a Moderate Buy consensus rating, based on 10 Buys and five Holds assigned in the past three months. The average Enbridge price target of $45.55 implies 9.9% upside potential.
Conclusion
Enbridge enjoys very high barriers to entry, making it difficult for new entrants to disrupt its operations. In addition, it has provisions in its contracts to help shield it from the cyclical nature of the energy industry and inflation.
We remain neutral because we personally don’t like investing in commodity-based businesses. Nonetheless, the stock is worth considering for investors who are interested in exposure to the energy industry.
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