Morningstar: Downgrad to Narrow Mote We are downgrading Enbridge’s moat to narrow from wide, primarily due to concerns regarding the durability of midstream returns earned from serving Canadian oil and gas oil sands efforts. Our narrow moat is based on an efficient scale moat source. While we remain very confident in demand for Canadian oil (approximately 1.8% growth CAGR through 2030) and gas (9% CAGR over the same time frame) in the near to medium term, we are far more uncertain around long-term demand in the latter stages of our forecast due to the high carbon emissions intensity associated with the full cycle of oil sands production, which is a primary source for Enbridge’s assets. Oil sands carbon intensity is among the highest among all the basins we cover, and it is disproportionately exposed to threats if countries and governments continue to seek ways to reduce greenhouse gas emissions. We expect material stakeholder challenges from legal, regulatory (Enbridge already pays carbon taxes for instance), and community perspectives for any new major Enbridge project, and likely new oil sands projects from producers, challenging the investment case for new pipes and boosting costs for existing assets. Beyond stakeholder issues, we believe refineries that run a heavy crude slate that requires Canadian heavy are increasingly looking to renewable diesel (produced from food waste), raising significant questions around the sustainability of long-term demand. Finally, while the nascent hydrogen and other renewable opportunities offer ways for Enbridge to manage the energy transition, we believe at best, they could become narrow-moat businesses, further reducing our confidence in an overall wide moat rating.
Enbridge stands out among North American midstream operators with a focus on oil pipelines and a utility-like earnings profile. The firm's most important asset, its Mainline system, controls over 70% of Canada's takeaway capacity and is linked to highly complex U.S. refineries that value heavy oil, meaning demand remains secure in the near to medium term despite the increase in U.S. light oil production. Enbridge's size and high profile invites challenges for new projects, which we expect to become a permanent feature. The multi-year effort to bring Line 3 into service due to opposition from indigenous tribes finally looks to be nearing a close, with an expected in-service date by the end of 2021. At the same time, Line 5 is entering what is likely to be a protracted series of legal challenges with the state of Michigan regarding regulatory oversight. A third effort to shift Mainline contracting to long-term decade-plus contracts from an uncontracted monthly nomination system has been undertaken to lock in customers as competing projects were proposed, mainly Keystone XL (since shelved), and the Canadian government's Trans Mountain. As Keystone XL has failed, the new contracting structure becomes more useful to generate steadily increasing tariffs versus fending off competing pipes, and final approval of the new structure can require that Line 3 be in service. With major future pipeline projects unlikely for years at this stage on the scale of Line 3 at least, Enbridge's 5% to 7% growth profile is supported by the rest of its businesses, namely gas transmission, a significant utility based in Ontario, and a small renewables segment. Combined, Enbridge plans to invest $3 billion to $4 billion annually across its portfolio, with an incremental up to $2 billion available for buybacks and debt reduction as well as new organic development. The utility and renewables businesses offer opportunities in renewable natural gas, hydrogen, carbon capture, and wind, placing Enbridge among the leaders in midstream in terms of being able to address long-term demand and ESG-related concerns for oil and gas.
Our fair value estimate for Enbridge is $44 (CAD $53) per share. Our fair value estimate has declined from our prior $46 (CAD 59) estimate due to the shorter period of excess returns with the moat downgrade to narrow from wide
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