Dividend yields have fallen to lows not seen in decades. With the S&P 500 rallying double digits this year, the average dividend yield on stocks in that index is now at a 20-year low of 1.3%. That’s making it harder for income-focused investors to find attractive opportunities.
It also makes them question stocks with high dividend yields like Enbridge (NYSE:ENB), which currently clocks in at 7.2%. Here’s a closer look at whether the Canadian energy infrastructure giant can support that big-time payout.
Drilling down into the numbers
Enbridge has one of the best dividend track records in the energy sector. The company has increased its payout in each of the last 26 years, growing it at a 10% compound annual rate. Fueling its steady growth has been its ability to consistently expand its energy infrastructure footprint while maintaining a strong financial profile.
The company has a low-risk business model. It has a diversified business mix (liquids pipelines, natural gas distribution and transmission infrastructure, and power assets) secured by government-regulated rate structures and long-term contracts with financially strong customers. That provides Enbridge with durable cash flow. It typically pays out 60% to 70% of this steady income via its dividend, retaining the rest to reinvest in expansion projects. The company complements that conservative payout ratio with a strong, investment-grade balance sheet, giving it the additional financial flexibility to expand.
Between retained free cash flow after paying its dividend and debt capacity while maintaining its investment-grade balance sheet, Enbridge has about 6 billion Canadian dollars ($4.7 billion) of annual financial flexibility. The company can use those funds to invest in expansion projects — it currently has CA$10 billion ($7.75 billion) of spending remaining on its secured projects through 2023 — repurchase shares, pay down debt, or make acquisitions. This reinvestment level will support 5% to 7% growth in annual cash flow per share. That should allow Enbridge to maintain its dividend growth streak.
The company clearly has the financial profile to support its current dividend.
So then, why the high yield?
One of the driving factors behind Enbridge’s high yield is valuation. It has high confidence that it can generate between CA$4.70 and CA$5 ($3.65 to $3.88) in cash flow per share this year, thanks to its durable cash flows. With its stock price recently around $37, it trades at less than 10 times cash flow. That’s dirt cheap given that the S&P 500 currently trades at more than 20 times its forward earnings. Because of its lower valuation and higher payout ratio, Enbridge offers a much higher dividend yield than most other dividend stocks.
A few factors are weighing on Enbridge’s valuation. First, oil prices have been very volatile in recent years, which has hurt the sector. Some energy infrastructure companies have experienced lower fee-based volumes, reduced commodity-based earnings, and customer bankruptcies.
But it hasn’t affected Enbridge’s earnings due to its highly resilient business model. Only 2% of its cash flow is at risk in any given year due to its contract structure and focus on working with investment-grade customers. Still, the sector’s issues have weighed on the entire industry, including Enbridge’s valuation.
Another factor that seems to be holding down Enbridge’s stock price is the energy transition to cleaner alternatives. The global economy is rapidly decarbonizing. That has investors worried that much of Enbridge’s infrastructure will become obsolete.
But despite the acceleration in recent years, the energy transition will take decades. That’s giving Enbridge time to gradually transition its business. It has already come a long way, shifting its business mix toward cleaner natural gas and renewable energy. Over the last decade, gas infrastructure has gone from 33% to 43%, while renewable power has increased from 2% to 3%. Those factors reduced its exposure to liquids pipelines from 65% to 54%.
That pivot will continue in the coming years. Enbridge has a significant backlog of gas infrastructure and renewable energy projects under construction and in development. Of note, it’s building several offshore wind farms in Europe and investing in solar energy self-powering projects to reduce the carbon footprint of its liquids pipelines. Meanwhile, it has billions of dollars of lower-carbon opportunities in development to continue transitioning its business in the future.
These investments should enable Enbridge to replace its carbon-intensive cash flows while growing its business in the decades ahead. That should allow the company to continue supporting its dividend.
A well-supported high-yield dividend
Enbridge is having no trouble supporting its dividend. The company generates durable cash flows and pays out a reasonable portion of that money via the dividend. When combined with its strong balance sheet, it retains more than enough cash to grow its business at a healthy rate. And it’s gradually cleaning up its carbon footprint, which should enable dividends to keep flowing and growing for years to come.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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