This article comes from Globe&E-Mail this morning, makes for interesting reading and certainly confirmes what some members of this board - I mean You "when2buy" - have been saying for some time.
The cracks in the Enbridge dividend story
DAVID MILSTEAD SPECIAL TO THE GLOBE AND MAIL
"Enbridge Day," the pipeline operator's annual conference for the investment community on Dec. 12, couldn't come soon enough, apparently.
The company spooked the markets in early November with its third-quarter earnings report, which failed to reiterate its dividend growth goals. The stock shed more than 10 per cent within a couple of weeks, careening from about $50 to below $44 at one point. All is well once again? Last Thursday, the company pre-empted Enbridge Day with the announcement that it will improve its balance sheet with a multibillion-dollar package of asset sales, new stock sales and borrowings.
This sent the shares up, and they're now nearly back to their predisappointment levels. Enbridge will continue to fund its "industry leading secured growth program." And, yes, it will also increase its dividend by at least 10 per cent annually, as previously expected. Growth company or income investment: Why choose if investors don't make you?
I'll stake out a position on the fringe of the Canadian investment community: It's not enough for Enbridge to abandon its plan for 10-per-cent-plus dividend growth. This company has little business paying a dividend in the first place (certainly not one as generous as this, $2.684 annually per share, for a yield of more than 5 per cent). And since Enbridge thinks it can still do it all, it's more a reason to get out than buy in.
You don't need to talk to short-sellers – and there are a few on this name – to arrive at this conclusion. It merely takes a close examination of the financial statements. Enbridge is an example of a company that has convinced investors with its earnings announcements that it is an income stock with a healthy dividend, when in fact the official cash-flow statement, calculated in accordance with generally accepted accounting principles, suggests otherwise.
In the third quarter, for instance, the company said its "available cash flow from operations," or ACFFO, was $1.33 billion, or 82 cents per share, and it re-affirmed its guidance for 2017 ACFFO of somewhere between $3.60 and $3.90 per share.
How does management arrive at this number? Among the adjustments it makes is deducting only the portion of capital expenditures it deems "maintenance," or required to support and maintain the existing pipeline system. It excludes spending on its existing systems that "that extend asset useful lives, increase capacities from existing levels or reduce costs to enhance revenues or provide enhancements to the service capability of the existing assets." All of the capital expenditures that relate to expansion and growth are not deducted from ACFFO.
In using this construct on capital expenditures, Enbridge is not alone, and there can be legitimate distinctions between maintenance and growth capital. But the lines Enbridge draws should allow investors to wonder whether maintenance capital, and the cash-flow measure that flows from it, presents a full picture of how much the company needs to spend.
For the third quarter, Enbridge reported $360-million in maintenance capital expenditures. Total capex was $1.95-billion. Depreciation, a measure of how much of the company's property, plant and equipment was "used up" in the period, was $848-million.
Enbridge said it spent just $42-million on maintaining its liquids pipelines in the third quarter. These pipelines depreciated to the tune of $377-million and were recorded on the balance sheet as worth $55.5-billion.
In other words, in the quarter, maintenance capex on the company's biggest batch of assets was less than one-tenth of 1 per cent of their stated value.
Enbridge tells investors ACFFO, along with other non-GAAP measures, "gives useful information to investors and shareholders as they provide increased transparency and insight into the performance of the company." Enbridge's management uses ACFFO "to assess the performance of the Company and to set its dividend payout target."
But my math, above, suggests that while a big chunk of capex is designed to promote growth projects, a significant amount of it could also be considered necessary to replace the assets that Enbridge is currently using to generate earnings – and should likely be considered when evaluating the company's cash flow and dividend. ACFFO doesn't do it. For the long-term view, I looked at cash-flow data in Standard & Poor's Global Market Intelligence. I took cash from operations, as presented, and subtracted the entirety of capital expenditures, without management's distinctions about what was maintenance and what was growth. There's no definition of "free cash flow" under formal accounting standards, but plenty of rigorous investors will use this one.
In the last 10 years, from 2007 on, it was only in 2016 that Enbridge actually posted positive free cash flow, a paltry $83-million. The 10-year total is a staggering $24.1-billion in negative free cash flow. That's before paying out $7.4-billion in dividends. Perhaps not coincidentally, the company issued almost $25.6-billion in net debt over that decade. It now has $65-billion in debt on its books, including the tens of billions it took on in the merger with Spectra Energy Corp. this year.
This definition of free cash flow, to be clear, is a harsh judgment for a company with significant, long-running capital expenditures for its core pipeline business. Indeed, the investment case is that this has been a golden era of growth in the pipeline industry, and Enbridge believes it has an excellent set of projects to invest in — many of which, of course, come on line and produce profits years after the capital expenses. Enbridge cannot grow if it does not spend.
But it has consistently spent more than it has taken in, through good years and bad, ramped up debt, and still wooed investors as a dividend story.
Enbridge, in my view, simply doesn't have the cash-flow profile to be an income investment. Yet it will get away with it as long as Canadian investors keep buying the stock it repeatedly issues, and lending it the money it needs to prop up its model. Enbridge bills itself as "an investment you can trust." The Canadian marketplace continues to agree, whether the numbers make sense or not.
THE MISSING BILLIONS ENBRIDGE EMPHASIZES 'AVAILABLE CASH FLOW FROM OPERATIONS' TO INVESTORS WHEN IT TALKS ABOUT THE SUSTAINABILITY OF ITS DIVIDEND. IN CALCULATING THIS MEASURE, IT IGNORES MOST OF ITS CAPITAL EXPENDITURES, DEDUCTING ONLY 'MAINTENANCE' CAPEX TO ARRIVE AT THE NUMBER. THAT HAS LEFT BILLIONS OF DOLLARS OF CAPEX OUT OF THE MEASURE OVER TIME. WHEN ALL OF THE COMPANY'S CAPITAL EXPENDITURES ARE DEDUCTED FROM OPERATING CASH FLOW, ENBRIDGE POSTS NEGATIVE FREE CASH FLOW IN NEARLY EVERY YEAR. STILL, THE COMPANY PAYS DIVIDENDS — AND ISSUES DEBT, AS WELL.