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Enbridge Inc (NYSE:ENB) is the largest pipeline company in North America. Shipping 3 million barrels of oil a day, it is a cornerstone of the regional economy. Enbridge plays such a large role in energy transportation that a full 45% of the oil refined in Ontario and Quebec comes through its pipelines.
But now, Enbridge's U.S. operations are under threat. In November of 2020, the Governor of Michigan revoked Enbridge's 1953 easement, which gave it permission to operate in the state. According to the Governor, Enbridge has until May 12 to shut down its Line 5 pipeline in Michigan
As of this writing, that date was just under a month away. That's significant because Line 5 transports 540,000 of the 3 million barrels of oil Enbridge ships daily. If Enbridge is forced to shut down the part of the line that goes through Michigan, then it will come at a substantial cost to its business. At present, Line 5 moves about 18% of all the crude oil Enbridge transports. That doesn't necessarily mean it provides 18% of the company's revenue - tariffs vary by geographic area - but it does mean that Line 5 is a significant contributor to Enbridge's revenue.
Depending on how it played out, a Line 5 should down cut hurt Enbridge's ability to pay dividends. That would negatively impact the thesis for buying the stock, since investors who like ENB, like it because of its income potential. Pipeline stocks are similar to utilities and REITs in that they typically pay a large percentage of their earnings out as dividends. In ENB's case, that has resulted in a whopping 7% yield and 10.72% annualized dividend growth. When you start from 7% and grow at 11% a year, you end up with a staggering yield-on-cost in very short order.
Unless, of course, something unexpected happens to kill the earnings growth. Companies can't pay above 100% of their earnings as dividends forever, so lower earnings plus a high payout ratio eventually means lower dividends.
Today, ENB has a 71% payout ratio based on distributable cash flow (DCF) - that is, the cash it is able to pay out. The payout ratio based on net income is 126%. These are already fairly high ratios, and the closure of Line 5 could make them far worse. If you knock out 18% of a pipeline's capacity out, that's going to have an effect on revenue and earnings. And with that, a higher payout ratio and possible dividend cuts.
So the situation in Michigan is a real threat to Enbridge. If the State gets its way, then it will have a measurable, negative impact on Enbridge's earnings. There is no question about that. There is, however, a question about whether it will actually happen. In a recent press release, Enbridge said that it had no intention of shutting Line 5 down. So far, the company has made good on that promise, keeping its Michigan infrastructure fully operational. In a letter to Gov. Whitmer, ENB said that the State "lacked the authority" to revoke its easement. Given this, it is safe to assume that Enbridge will not shut down Line 5. For this reason, I will develop a bullish thesis on Enbridge, arguing that its dividend is safe despite the apparent threat.
Competitive Landscape
Before getting into the core of my thesis on Enbridge, it helps to look at the competitive scene the company operates in. Competition influences dividend paying ability, in that it impacts a company's earnings. So, it's something that Enbridge investors should pay attention to.
Enbridge is a midstream energy company, mainly involved in transporting crude oil. It also operates as a natural gas utility. In its main business area (pipelines), Enbridge has several notable competitors:
- MPLX (MPLX), a U.S. pipeline company whose map overlaps with Enbridge's own in places.
- TC Energy (TRP), a Canadian pipeline company.
- Pembina Pipeline Company(PBA).
- And others.
Among these companies, Enbridge is by far the dominant player. It has the longest crude oil pipeline network in North America. It transports 25% of North America's crude oil, including 65% of Canada-U.S. shipments. It supplies about 45% of Ontario and Quebec's energy needs. Put simply, it's a major player in its space. And with competitors like TRP having their pipeline projects cancelled, it should remain one - unless, that is, Enbridge's own infrastructure gets the axe.
What Michigan Wants
The pipeline dispute between Enbridge and Michigan pertains to an easement the company obtained in 1953. An easement is a document that gives you the right to operate on someone else's land. In November of last year, Michigan's governor revoked that easement, and gave Enbridge until May 12 to comply. So far, it has not. And most likely, it will not, even when the deadline arrives. There are three facts that support this prediction:
- Enbridge wrote Michigan officials questioning the Governor's authority to revoke its easement. This implies that the company doesn't see the order as enforceable.
- The company's lawyer wrote that the pipeline will "continue to operate until replaced" by a new tunnel. The tunnel is not scheduled to be complete anywhere near May 12, so the statement implies that Enbridge will keep Line 5 running beyond that date.
- Enbridge has vowed to challenge the State's actions in court if a political solution can't be reached.
Taken as a whole, these facts strongly suggest that Enbridge won't shut down Line 5 even after May 12. Nevertheless, we should look at the financial implications if it were somehow forced to. Say, if the U.S. federal government got involved and sided with the State of Michigan. I'll explore that in the next section.
Business Implications of a Line 5 Shutdown
The shutdown of Line 5 would have an enormous impact on Enbridge's business. The line supplies about 18% of the crude oil Enbridge transports. The revenue lost if it were shut down would be immense.
A quick glance of Enbridge's tariff sheets shows that it charges between $10 and $16.50 per cubic meter on the Michigan part of its pipeline. This is in contrast to other States where it charges as little as $2.8. So, Line 5's revenue contribution may be even bigger than its contribution to Enbridge's barrels shipped.
How would the loss of that contribution affect investors?
One obvious implication would be putting the dividend under fire. Enbridge has not only paid but also raised its dividend every year for the last five years. Its compound annual dividend growth rate is 10.72%. Even today, it yields an incredible 7%.
Take Line 5 out of the picture, and that would be in jeopardy.
Currently, Enbridge's dividend is well supported by cash flow. In 2020, Enbridge had $4.67 in distributable cash flow (DCF) per share. It paid $3.34 per share in dividends. That gives Enbridge a 71% DCF payout ratio for 2020. If we use net income instead of cash flow, we end up with a ratio above 100% - but cash flow is a better measure of dividend paying ability than earnings, because it doesn't include unrealized gains and losses.
So, as everything stands today, Enbridge is more than able to pay its dividend. But the loss of Line 5 would call all that into question. If Line 5 were shut down, that would be 540,000 barrels a day not moving. Enbridge would lose hundreds of millions in revenue because of that, potentially pushing its DCF payout ratio over 100%. If that happened, then the dividend would have to be cut. It does notlook like it will happen anytime soon. As mentioned, Enbridge plans to continue operating Line 5, easement or no. But it's a possibility investors need to consider.
Risks and Challenges
As we've seen, Enbridge is unlikely to shut down Line 5 this year, and its ultra-high dividend yield is not in jeopardy. So far, the story is looking pretty good. But there are several risks and challenges to my thesis. A few of the more important ones include:
- Federal government involvement. One of the reasons Enbridge believes it can keep operating Line 5 in Michigan is because it thinks the State lacks the authority to stop it from doing so. That would be harder to argue if the U.S. federal government got involved. Joe Biden hasn't been friendly to Canadian pipelines in the past. He recently cancelled TC Energy's massive Keystone XL project. If he got involved in Enbridge's Michigan drama, it likely wouldn't be to help Enbridge. Most likely, he'd side with the Governor.
- Legal risk. If Enbridge can't find a political solution to the Line 5 situation, it will have to defend its actions in court. An unfavorable ruling could force it to shut down the pipeline. If the matter went to a superior court, the company would have no choice but to respect the Justice's decision.
- Regulatory risk. Related to legal risk is regulatory risk. President Biden has signaled his intent to shift to alternative energy. With that might come extra safety, environmental and land-use regulations for pipelines. It's not looking like Biden is going to flat-out shut down Enbridge infrastructure. But costly regulations could be in the cards.
The Bottom Line
The bottom line with Enbridge is this:
Its ultra-high dividend yield is safe for the time being.
The company only pays 71% of its distributable cash flow out as dividends, and it will likely continue operating Line 5 for the foreseeable future.
Yes, there are risks. An unfavorable court decision or federal government action could easily land ENB in hot water. But the company appears confident that it can ignore Michigan's demands for the time being. If it's right, then investors will keep getting the big dividends they've gotten accustomed to from ENB.