Upgrading Enbridge to Outperform from Peer Perform. Enbridge has arguably done as good a job as any other company in the space realigning its balance sheet and financing plan to reflect the new realities of the capital markets. ENB sold over CAD$7B in assets in 2018 and moved its leverage to below 5x several years ahead of plan. Beyond that the company also moved to simplify its (very) complicated structure by rolling up its sponsored vehicles. ENB now has a nearly 7% yield, clarity on 10% annual growth through 2020, and 5%-7% growth longer term - all without the need to issue equity via block or even DRIP. We believe this profile is what most large cap midstream companies should look like. Finally, we like the defensive characteristics of the company as well - most of its assets are long term contracted or utility like, and it should do relatively better in periods of volatility (also, at 15x 2020 EPS, it is less expensive than a utility). See our detailed sector note here.
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Enbridge now our preferred Canadian midstream name. We are upgrading Enbridge to Outperform from Peer Perform and it is now our preferred Canadian midstream name. ENB executed very well in 2018: fully simplifying, repairing its balance sheet with significant asset sales, and getting Line 3 Replacement approved. It has become what we see as a prototypical large cap midstream model: high yield (7%), high growth (10% through 2020, 5%-7% sustainably thereafter), and no foreseeable need to access the equity markets. Finally, ENB is well positioned for Canadian crude takeaway given the uncertainty over TMX and KXL, and it appears headed to reduce volatility further under a long-term tariff agreement on the Mainline. We are boosting our target price to $37 from $36.
Attractive valuation, but with late cycle multiple compression risks. Midstream stocks offer low double digit total return (dividend + growth), which is attractive at this point in the cycle especially for a relatively low risk business. Relative EV/EBITDA multiples are slightly below the SPX and UTY, and P/E is now in line with the market. We saw a 10-20% compression of EBITDA and cash flow multiples in 2018. The risk is market multiple compression in 2019, which has an amplified effect on equity values for a levered sector.
Terminating coverage of EEP on ENB rollup completion . On December 17, unitholders of Enbridge Energy Partners approved its acquisition by Enbridge and the transaction closed on December 20
We think that Enbridge did a good job at the analyst day highlighting a low-risk, self-funded model with visibility on growth in out years. After the excitement over the last few years on digesting Spectra and addressing the balance sheet, the focus can now be on execution on a better-scaled growth plan and a simpler structure. We remain Peer Perform as the stock trades at a (warranted) premium to the midstream peers but we believe ENB’s defensive nature has more appeal in this environment.
Q3 results were even better than we expected. None of our covered companies missed with a median EBITDA beat for the quarter of 5%. More importantly, the median DCF / share growth in Q3 was 18%!! This figure excludes companies involved in M&A and is more reflective of true growth in the business – see p. 2. While this pace of growth clearly won’t last forever, what other sector is paying a 7-8% yield and growing cash flow per share by almost 20%? The fundamental picture is very strong, balance sheets are improving, and equity needs have been dramatically reduced. EPD’s CEO Teague stated this is “the strongest business climate we have seen in recent memory.”
2018 has been all about execution on ENB’s financial and strategic plan to reduce leverage and fund the growth plan. To date the company has been successful. In Q3 ENB got approval of Line 3 Replacement, finalized terms for the simplification of the sponsored vehicles and closed on some asset sales. ENB now has a much-improved balance sheet (and turned off its DRIP) and a few years of 10% growth ahead. We see the stock trading at a modest premium to the midstream group which we believe is warranted. Maintain Peer Perform.
We are forecasting Q3 EBITDA growth of nearly 15% vs. last year, with median DCF per share rising by 15% YoY as well. Fundamentally, the sector continues to benefit from positive dynamics as production volumes accelerate across most key basins, new projects come into service, and wide locational price differentials highlight the need for new infrastructure investment. The Q3 fundamentals are similar to Q2 which saw strong results and the AMZ outperform the market by 8% over the course of earnings season. However, unlike Q2 we see consensus as largely there; we have a roughly even split of beats and misses vs. consensus. So it’s less clear to us if Q3 will again be a positive catalyst or more neutral near term. Ultimately, we believe that as the companies continue to show above-average growth, simplify, and get to sustainable leverage, investor support for the sector will increase.
We have worked with BNP Paribas to create a reference custom basket of 15 midstream stocks held in a C-corp structure or that file a form 1099 and are taxed as corporations. The basket can be accessed on Bloomberg (BNPBCCOR INDEX) and is customizable and tradeable – contact your Wolfe salesperson for details.
Enbridge Q2 results were solid across the board, the third quarter in a row that beat consensus. The company further guided to the upper half of the prior 2018 DCF/sh range of $4.15-$4.45 and reiterated 2018-20 EBITDA guidance. The quarter had a lot of positives apart from good Q2 results – a favorable decision on L3R in MN and better than expected asset sale outcomes. Enbridge is executing well on numbers and on the strategic plan - slowly but surely easing investor concerns. Finally, the overall structure is becoming much simpler with the sponsored vehicle rollups. That said, ENB’s current premium appears to be baking these positives in the stock; Peer Perform.
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