A Safe 7% Dividend Yield in the Energy Sector

Investing in energy stocks can seem like walking through a minefield these days. The Energy Select Sector SPDR Fund XLE, a popular energy stock ETF, has declined over 40% in 2020. Weak energy prices caused by a global supply glut and lower demand from the coronavirus pandemic has brought the entire energy sector down. The result is that a number of high-profile energy stocks have declined significantly this year, with many also cutting shareholder dividend payouts. Royal Dutch Shell and BP plc are just two of the many well-known energy stocks that have announced dividend cuts this year. Safe dividends can still be found among energy stocks, but investors need to be more selective by focusing on companies with strong assets, healthy balance sheets and resilient cash flow. We believe Enbridge has a safe dividend payout, and with a high dividend yield above 7%, the stock is attractive for income investors. Business Overview Enbridge is an integrated oil and gas company based in Canada. It operates a variety of businesses including Liquids Pipelines, Gas Distributions, Energy Services, Gas Transmission & Midstream, and Green Power & Transmission. The company has a market capitalization of $65 billion. Not surprisingly, the current environment is extremely challenging due to the combination of low oil and gas prices, as well as the coronavirus pandemic which has sent the global economy into recession. But the company continues to generate positive cash flow. In the 2020 second quarter, Enbridge saw its revenue decline approximately 40%. However, Enbridge's adjusted EBITDA increased 3% from the previous year's quarter, as revenue declines were fully offset by lower costs. The company enabled $300 million of cost savings during the second quarter. And, despite the coronavirus crisis, Enbridge maintained its guidance for distributable cash flow per share of $4.50 to $4.80 (in Canadian currency) for 2020. At the midpoint of guidance, Enbridge expects to increase DCF per share by approximately 2% in 2020. Contrast this with most other integrated oil and gas majors, which are posting steep declines in cash flow and earnings, many of which are also reporting losses. By comparison, Enbridge expects to remain profitable and generate growth this year, a highly impressive feat. Strong Assets and Lean Operations Fuel Growth The major reason why Enbridge has maintained its dividend over the course of 2020 while so many energy stocks have had to cut dividends, is the company's strong business model. Enbridge owns high-quality assets across the business, which generate cash flow, even during periods of weak commodity prices. For example, Enbridge's liquids business has refining capacity of over 12 million barrels per day, while its gas business serves over 170 million people. Approximately 95% of Enbridge's counterparties have investment-grade credit ratings. And with over 40 diverse sources of cash flow and a BBB+ credit rating, it is clear that Enbridge has a large and diversified network of integrated assets, a healthy balance sheet, and opportunities for future growth. Liquidity is not much of a concern for Enbridge, as the company has $14 billion of available liquidity and its debt-to-EBITDA ratio remains within its target range of 4.5x to 5.0x. Indeed, Enbridge has executed $30 billion of capital projects since 2016. These investments, along with previous investments made over the past many years, have fueled the company's impressive growth. Since 2008, Enbridge has increased its dividend by a compound annual growth rate of 14% per year. Going forward, Enbridge is confident that it can continue generating growth, even in a difficult environment marked by the coronavirus pandemic and weak commodity prices. Company management forecasts 5%-7% average annual distributable cash flow growth through 2022. Approximately 1%-2% of this growth will be achieved by optimizing the base of its assets through embedded toll escalators and cost savings, while the remaining 4%-5% annual DCF growth will come from new projects coming online. Dividend Analysis Enbridge currently pays a dividend of $0.81 per share in Canadian currency, equaling $3.24 on an annualized basis. With expected DCF per share of approximately $4.65 at the midpoint of 2020 guidance, Enbridge's dividend payout ratio is expected to reach approximately 70% for the year. This indicates a safe dividend payout, especially considering the high-quality assets and healthy balance sheet. Therefore, while there are never any guarantees when it comes to dividend stocks, investors can be reasonably confident Enbridge will make it through the 2020 pandemic without needing to cut its dividend. Investors should note that since Enbridge is based outside the U.S., currency fluctuations will play a role in the dividend payments received. As a Canadian stock, a 15% dividend tax will be imposed on U.S. investors investing in the company outside of a retirement account. However, the tax is waived for investors who own the stock inside a retirement account such as an IRA. Based on current prevailing exchange rates between the Canadian and U.S. dollar, Enbridge's annualized dividend payment works out to roughly US$2.48 per share. This equals a current dividend yield of 7.7% for Enbridge stock, a very attractive yield in today's low-rate environment. With the average dividend yield of the S&P 500 Index below 2% right now, Enbridge stock is highly appealing by comparison. Final Thoughts Investing in the energy sector is no easy task. The combination of low commodity prices and weak demand caused by the coronavirus pandemic has dealt a series of blows to the entire energy sector. Many lesser-quality energy stocks have had to cut or suspend their dividends over the course of the year, and it is likely more dividend cuts are on the way as the industry struggles with excess debt. Therefore, investors need to be selective when sizing up the energy sector for potential investment. We believe Enbridge has a secure dividend due to the company's recession-resistant business model and high-quality assets. With a high dividend yield of 7.7%, we rate Enbridge as a buy for income investors.

A Safe 7% Dividend Yield in the Energy Sector

Canadian company has maintained its dividend over the course of 2020 while many high-profile energy stocks have had to cut dividends.

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