I would like your opinion on pipelines – namely Enbridge and TC Energy. The stocks have been hit hard and I am wondering if I should take my lumps and move on.
With investors increasingly focused on environmental, social and governance (ESG) factors, oil and gas pipelines have been getting the cold shoulder. Enbridge Inc. (ENB) and TC Energy Corp. (TRP) have tumbled about 25 per cent and 17 per cent, respectively, this year, while renewable power stocks have soared in price. The severe economic contraction triggered by the coronavirus pandemic has only added to investors' unease with pipeline stocks.
But as much as we all want the world move to carbon-free energy as soon as possible, the reality is that the transition will take decades. Oil and gas – and the pipelines that transport them – aren’t going away any time soon, despite what the depressed share prices of Enbridge and TC Energy seem to be saying.
“Sentiment is carrying the day,” Robert Kwan, an analyst with RBC Dominion Securities, said in a recent note to clients. But strictly from a financial standpoint, “we believe that the current share prices represent attractive value for long-term investors, especially those seeking above-average dividend yields.”
Enbridge and TC Energy yield about 8.4 per cent and 5.7 per cent, respectively. The yields are even more appealing given that both companies plan to continue raising their dividends as they deploy billions of dollars into capital projects over the next several years.
Enbridge, which hiked its dividend by 9.8 per cent last December, has said it expects to raise its payout by 5 per cent to 7 per cent annually, in line with its expected growth in distributable cash flow. TC Energy, which raised its dividend by 8 per cent in February, expects to boost its dividend by 8 to 10 per cent in 2021 and 5 per cent to 7 per cent thereafter.
Future dividend growth is one reason analysts are still giving pipelines lots of love. Mr. Kwan has an “outperform” rating on both stocks – and he has plenty of company. According to Refinitiv, Enbridge has 22 buy or equivalent ratings, four holds and one sell. TC Energy has 19 buys, five holds and no sells.
Analysts also point to the companies’ cheap valuations. In a note to clients on Friday, Scotia Capital analyst Robert Hope said that, with money flowing away from pipelines and into renewable power and utilities stocks, Enbridge and TC Energy are trading at substantial discounts to their long-term average price-to-earnings multiples.
But investor funds could begin flowing back into pipelines, given their attractive valuations and “resilient and low-risk business models that are well positioned to grow longer term,” Mr. Hope said. He reiterated “sector outperform” ratings on both stocks.
Recent financial results have also been encouraging. In July, Enbridge – which transports about 25 per cent of North America’s crude oil and 20 per cent of natural gas consumed in the United States – reported better-than-expected results for the second quarter, as crude oil volumes fell less than expected. Despite the economic hit from the pandemic, the company also reaffirmed its full-year distributable cash flow guidance.
Enbridge has also taken steps to strengthen the company. The 2017 acquisition of Spectra Energy Corp. added extensive natural gas transportation assets that helped diversify Enbridge’s oil pipelines business. In addition, Enbridge has fortified its balance sheet by selling non-core assets, which has reduced its debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratio to the low end of its target range of 4.5 to five – down from more than 5.5 in 2017 – and helped to protect its investment grade credit ratings.
TC Energy – which derives more than two-thirds of its EBITDA from natural gas pipelines – also reported solid second-quarter results and reaffirmed its 2020 guidance. With about 95 per cent of its EBITDA coming from assets that are either regulated or contracted on a long-term basis, “we continue to be largely insulated from short-term volatility associated with volume throughput and commodity prices,” the company said. “Despite the challenges brought about by COVID-19, TC Energy’s assets have been largely unimpacted."
What’s more, TC Energy said it continues to advance its $37-billion program of secured capital projects. Even if one excludes the US$9.1-billion Keystone XL pipeline expansion – which U.S. Democratic presidential candidate Joe Biden has vowed to block if elected – “TC Energy remains confident in its ability to grow its annual earnings in the 5 to 7-per-cent range based on investing roughly $5-billion per year of capital,” RBC’s Mr. Kwan said.
The switch to renewable energy could even have a silver lining for TC Energy. As North America transitions away from coal and builds more wind, solar and hydro generation, there will be growing need for gas-fired plants to serve as a backup for renewable power sources "at least until other technologies are scalable and cost-effective [such as] batteries and other forms of energy storage,” Mr. Kwan said.
With pipelines dogged by negative investor sentiment, a quick rebound in their stock prices may not be in the cards. But for investors seeking above-average yields and dividends that will almost certainly grow for years to come, these stocks still deserve a spot in a well-balanced portfolio as the world moves to a greener future.
Full disclosure: The author owns shares of ENB and TRP personally and in his model Yield Hog Dividend Growth Portfolio (tgam.ca/dividendportfolio).
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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John Heinzl