A stock doesn’t get into value territory without having its share of headwinds. This is true for Enbridge (ENB), whose stock is now once again below $30. It is then up to the investor to determine if it is a value stock or a value trap. In this article, I show why I believe Enbridge the former rather than the latter, and what it makes an attractive investment at present; so let’s get started.

(Source: Company website)

A Look Into Enbridge

Enbridge is one of the largest energy companies in North America. It transports about 25% of crude oil produced in North America, and nearly 20% of the natural gas consumed in the U.S. It also operates North America’s third-largest natural gas utility by consumer count, and was an early investor in renewable energy, with a growing offshore wind portfolio. As such, its business is categorized into three segments: liquids pipelines, natural gas pipelines, and utilities and power. In 2019, Enbridge generated over $38B in total revenue.

As seen below, Enbridge’s large integrated network is connected to nearly all of the major energy plays in North America. It also has a joint venture with Enterprise Products Partners (EPD) to build an offshore export terminal in the Gulf of Mexico.

(Source: Company Earnings Presentation)

To be fair, Enbridge has had challenges, not least of which is from COVID, which has impacted energy demand worldwide. In addition, the transition to renewables and opposition to energy development present medium to long term challenges. The near term challenges were reflected in the decreased volumes on its mainline (liquids pipelines), which was 85% utilized during the second quarter.

In addition, the controversial Dakota Access Pipeline, in which Enbridge has a 28% stake, is at risk of a shutdown. The latest court papers reveal, however, that the pipeline is likely to continue operating through at least the end of the year. Additionally, BofA (BAC) noted that Enbridge is “well positioned to mitigate the loss of the crude capacity because of its extensive network of crude pipelines.”

Moving beyond what I see as short-term challenges, what I like about Enbridge is its diversified business model, which enabled it to offset the weakness in its core liquids pipelines business. As seen below, Enbridge saw strong growth in its Gas and Renewable segments, which helped to grow the overall adjusted EBITDA by 3.4% YoY.

(Source: Company Earnings Presentation)

In addition, I see Enbridge as being overly punished by headline-risk around crude oil volumes. That’s because Enbridge has strategically-located refineries which management noted as having rebounded faster than the rest of the market. This is supported by relatively quick recoveries in mainline deliveries to its Gulf Coast, Minnesota & Chicago, and Eastern Canada Markets, which, in the early part of Q3, were operating at 120%, 98%, and 86% of pre-COVID levels, respectively.

Looking forward to Q3 results and beyond, I’m expecting a continued recovery in liquids volumes. In addition, I see the company’s natural gas segment picking up steam, as worldwide demand recovers. This is supported by research from the IEA (International Energy Agency). As seen below, the IEA expects increased natural gas demand in all geographies, with the Asia Pacific region accounting for over half of the incremental demand from now through 2025. I see this as being a good indicator of growth for Enbridge’s natural gas export business.

(Source: IEA)

In the meantime, Enbridge’s balance sheet remains in good shape, with a BBB+ credit rating from S&P. In addition, management expects ending 2020 Debt to EBITDA to remain within its target range of 4.5x to 5.0x. While Enbridge’s leverage ratio is not the lowest in the sector, I see it as being relatively safe, especially considering the strategic nature of the company’s assets.

Turning to valuation, at the current price of $29.83 and a blended P/EBITDA of 6.1, Enbridge is trading well below its historical P/EBITDA of 8.9. Analysts also share a bullish sentiment, with an overall Buy rating (score of 4.2 out of 5), and an average price target of $39.05, which sits 31% above where the shares are trading at today.

(Source: F.A.S.T. Graphs)

Additionally, management re-affirmed its 2020 DCF guidance of $4.50 to $4.80 per share, which, at the midpoint, still represents a 1.8% YoY increase.

(Source: Company Earnings Presentation)

In the meantime, I find the 8.2% forward dividend yield to be attractive. Based on the midpoint of 2020 DCF guidance, the dividend payout ratio sits at a safe 52.5%, which leaves ample room for debt reduction and capital investments. As seen below the current dividend yield range is at the highest level in over 20 years. Note that the following 7.9% yield is based on the TTM dividends.

(Source: YCharts)

Investor Takeaway

Enbridge has seen some near-term headwinds from COVID, as its crude oil volumes have declined. However, I see the company as being resilient, due to the strategically-located nature of its refinery assets, which have seen a faster recovery than the rest of the market. Additionally, the diversified nature of Enbridge’s business, and the expected growth in demand for natural gas provides a strong offset as crude oil volumes continue to recover.

Longer term, I see Enbridge’s renewable power generation business as being a strong growth driver, and a good hedge for riding the energy transition trends. Lastly, the shares are trading well below historical valuations, and I find the 8.2% forward dividend yield to be attractive, especially in the current low-rate environment. For the aforementioned reasons, I see strong upside for the share price.

While there is no telling what the share price will do in the short term, I find Enbridge to be attractive enough for me, and have initiated a position, as I see strong upside in the medium to long term.

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Disclosure: I am/we are long ENB,EPD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.

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