Enbridge Inc. (NYSE:ENB ) has become one of my top picks in the stock market, and I'm excited to dedicate an entire article to this Canadian midstream giant. While I've mentioned Enbridge in previous articles this month, I believe it's worth taking a closer look at what makes this company stand out.

Originally, I saw Enbridge as a long-term play on the natural gas and LNG boom, but it has since become one of my favorite high-yield stocks. While I typically focus on dividend growth, Enbridge has all the qualities I look for in a high-quality dividend stock. The company plays a vital role in the global energy infrastructure and has a mature business model with investment-grade customers and falling capital requirements. What's more, it boasts a high dividend yield of 7%, backed by steady and robust free cash flow, consistent dividend growth throughout cycles, and a valuation that makes sense.

Enbridge's appeal extends to both high-yield investors and those seeking a balanced yield for dividend growth. In this article, we'll explore why Enbridge is an attractive investment option for both groups and analyze the factors that make it a safe and profitable pick.

Without further ado, let's dive into the world of Enbridge and explore its potential for your portfolio.

Why would I invest in Enbridge?

If you were to ask that question to Enbridge, they would give you five good reasons. How do I know that? Well, it's part of almost all of their investor presentations (like this one).

With a market cap of $79 billion (in New York), Enbridge is the world's largest midstream company. If you're new to energy, midstream is the step between upstream and downstream. Upstream covers oil exploration and production (getting it out of the ground), while downstream is the process of turning it into usable products like gasoline and selling it to customers. Midstream connects the two by providing transportation services.

I have roughly 20% energy exposure in my dividend growth portfolio. This consists of Exxon Mobil (XOM), Chevron (CVX), and Valero (VLO). In other words, I have upstream and downstream exposure.

While midstream companies aren't must-own companies, they bring tremendous value to the table - especially if you're looking for quality income.

What sets (high-quality) midstream companies apart from upstream and downstream is that these companies tend to be less dependent on commodity prices. Upstream and downstream companies tend to be good sources of income, yet they come with tremendous volatility.

With that said, Enbridge has a massive network of pipelines and storage/export facilities. Its liquids segment alone ships roughly 12 million barrels per day. Enbridge's gas transmission pipelines service 170 million people and 10% of LNG exports.

The company believes that it is well-protected against competitors for several reasons. These include the fact that the company services the Western Canadian Sedimentary Basin (home to some of the world's largest oil reserves), North Dakota, and America's fastest-growing basin, the Permian Basin. It allows producers to ship their products at competitive prices to North America's largest refineries and export facilities. Sure, it has many competitors, but its scale and ability to finance this network give the company a big edge. I would refrain from investing in a small midstream company with high risks of servicing oil basins with rapidly falling production rates.

The overview below shows some of the major benefits that come with its massive network. On top of well-diversified cash flows, the company benefits from predictable cash flow. Unlike upstream companies that highly depend on oil prices, Enbridge benefits from the fees it charges for the transportation and storage of liquids.

Customers pay Enbridge for the use of its pipelines on a per-barrel basis or a fixed fee, depending on the terms of their contract. Enbridge's fees can vary based on factors such as the distance that the product needs to be transported, the volume of the product being transported, and the duration of the contract.

It also helps that 95% of the company's customers have investment-grade balance sheets. This is unique in the industry and prevents a sudden loss in contracted volumes in case industry players go belly up during recessions.

Moreover, Enbridge is a well-diversified company that is not heavily reliant on a few major customers, thanks to its extensive operations and considerable size.

With that said, let's talk about its dividend.

As I already briefly mentioned, I'm not a high-yield investor. However, I like keeping my average dividend yield between 2.6% and 3.0% for reasons that include my personal tax situation.

That said, Enbridge currently pays a C$0.8875 dividend per share per quarter. That's C$3.55 per year, which translates to a yield of 6.8%. As the company's dividend is in Canadian dollars, foreign investors encounter currency risks.

To illustrate the impact of currency fluctuations on dividends received, refer to the chart below. The chart compares dividends received on Toronto and New York-listed shares, which demonstrates how the fluctuation in the CAD/USD currency pair affects dividends. Although this variance may seem concerning, it is not an issue for me. With the exception of one of my 21 dividend holdings located in Canada, all of my holdings are based in the United States. As such, I am familiar with the currency risks involved, and both the US dollar and the Canadian dollar offer high stability. As an investor based in a EUR country, I can attest that cash flows from Canada are relatively stable, making it a suitable investment option.

With that said, investors not only benefit from a high yield, but they also benefit from relatively high dividend growth and high dividend stability.

Enbridge isn't a typical dividend growth stock. However, dividend growth is far from disappointing - especially in light of its juicy yield.

This dividend aristocrat, with more than 25 consecutive annual dividend hikes, hiked its dividend by 3.2% on November 30.

These are the historical dividend growth rates:

Since 2008, the company has hiked its dividend by 11.1% per year. However, dividend growth has come down, as the time range below includes the shale boom in the United States. This fueled growth tremendously. These benefits are now largely gone.

Needless to say, slower growth is expected. Nobody expects the ENB dividend to maintain double-digit growth. What matters is that growth is consistent, even if it's low.

Before we get to growth, we need to address dividend safety. Dividend safety is a major concern for a lot of people as the company has a dividend payout ratio of almost 120%. I highlighted this number in the table below.

The good news is that the dividend is extremely safe.

After all, the payout ratio is based on net income, not on free cash flow. In the case of Enbridge, that is a bit misleading.

To support my case, I am using the company's most recent financials. On a full-year basis, the company did close to C$3 billion in net income. That is down from 2021 due to a goodwill impairment of C$2 billion, which we can ignore for now. In 2021, the company generated C$6.3 billion in net income. In 2021, the company paid C$6.7 billion in dividends (this excludes preferred dividends). So, that's an issue. However, as we can see below, there are some major items we need to take into account. First of all, the company is subject to extremely high depreciation due to its massive infrastructure. After all, the company has more than C$110 billion in net property, plant, and equipment assets.

Depreciation isn't a cash outflow. Hence, we can add it to net income. In 2022, depreciation was more than C$4.3 billion! This helped the company to arrive at more than C$11 billion in operating cash flow in 2022.

Enbridge 2022 10-K (Via SEC, Includes Author Annotations)

Enbridge 2022 10-K (Via SEC, Includes Author Annotations)

Although there has been a notable improvement, we have not yet reached our desired outcome. It's crucial to consider adding back depreciation, but we must also account for capital expenditures, as it's essential for the company to sustain its operations and pursue growth.

The chart below shows (somehow, 2022 is excluded) annual capital expenditures ("CapEx"), free cash flow, and net debt. Free cash flow is operating cash flow minus CapEx. It's cash the company can spend on dividends, buybacks, and debt reduction.

In the first years of the shale revolution, CapEx requirements were extremely high. The company regularly spent between C$8 and C$10 billion on CapEx, causing free cash flow to fall and net debt to rise. After all, the company needed external funding to close that gap.

Now, the company is in a much better position. CapEx requirements have fallen. In the years ahead, CapEx is expected to fall to C$5.3 billion, which is expected to boost free cash flow to more than C$9.0 billion.

This would imply that the dividend is backed by an 80% cash payout ratio. A number that supports high dividend safety.

That said, the company has three capital priorities.

The company has a self-funded business model, which also prevents the dilution of existing shareholders.

DCF is calculated by taking Enbridge's earnings before interest, taxes, depreciation, and amortization (EBITDA) and then adjusting it for various items, such as maintenance capital expenditures, interest expense, income taxes, and other factors that impact Enbridge's ability to generate cash flow. The result is a measure of the cash flow that is available to pay dividends and fund growth projects.

The company has a 65% DCF payout ratio, which is in the middle of its target range of 60% to 70%.

Moreover, this is in line with my own calculations of free cash flow. Unless global energy demand were to implode and remain low on a prolonged basis, the dividend is very safe.

That said, capital priority number three is getting its own section in this article.

Capital allocation priority number three is:

The company prioritizes low-capital expansion goals to grow using its existing infrastructure. This mainly includes the expansion and modernization of the current infrastructure. According to the company:

We will prioritize low capital intensity and utility-like investments and then deploy any remaining investment capacity to the next available option. All of these opportunities fit our low-risk business model, exceed our risk-adjusted hurdle rates, have a strong strategic fit, and align with our ESG goals. The bottom line is we continue to be focused on maximizing shareholder value.

Investments include an aggressive expansion of its LNG network. The company expects LNG shipments in North America to triple to 30 Bcf by 2040. Needless to say, ENB is in a terrific position to benefit from that. The company expects to get an export share of 30% through its pipelines and terminals.

We serve four plants in the Gulf Coast soon to be five and we make up 20% of US LNG exports through our pipes. We've also secured [precedent] ("PH") agreements with two more LNG facilities that are pending FID. That's Rio Grande and Texas LNG and there could be more after that. If those do go ahead, we could see our LNG export market share rise to 30% or above.

The company is also focused on improving upstream operations in the Haynesville Basin, where producers of natural gas are dealing with pipeline bottlenecks. To smoothen LNG and natural gas operations, we'll need to see big investments in that area.

In addition to this, Enbridge has a 30% stake in the Woodfibre LNG project, a 2.1 million tons-per-year LNG export facility with 250 thousand cubic meters of floating storage located near Squamish in British Columbia. The project is backed by two long-term offtake agreements with BP Gas Marketing Limited, which account for 70% of the capacity for 15 years, with additional commitments in development for up to 90%, according to Enbridge.

By diversifying into upstream operations and investing in LNG projects like Woodfibre, Enbridge is positioning itself as a major player in the global energy market and demonstrating its commitment to sustainable growth for the future.

As a result, ENB is consistently growing. Also, note that this proves the comments I made earlier, with regard to its low-volatility business model (especially compared to upstream and downstream companies).

With that said, what about the performance and valuation?

Enbridge shares have achieved 12% in capital losses over the past ten years. That's an abysmal performance. However, the total return (including dividends) was much better at almost 50%.

Moreover, after a few years, the total return price is taking off again. I believe that the company will continue to outperform almost all stocks with similar yields on a long-term basis. After all, we should not forget that this stock yields 6.8%. There's a reason investors buy ENB. That reason is not to compete with the growth rates of Apple (AAPL) and co.

It also needs to be said that the company's qualities have allowed it to crush its competitors. Going back to 2011, ENB shares have returned 180%. The Alerian MLP ETF (AMLP) has returned just 38%. Again, this includes dividends.

With that said, Enbridge shares are now trading at 12.1x 2023E EBITDA of C$16.3 billion. This is based on its C$106.1 billion market cap, C$80.0 billion in 2023E net debt, C$3.5 billion in minority interest, C$6.8 billion in preferred stock, and C$460 million in pension liabilities.

I believe that this valuation is fair. While my personal opinion is that economic woes could give us a better entry, starting a position at current prices isn't a bad idea given the yield of 6.8% and this valuation.

In summary, Enbridge Inc. is a Canadian midstream company that offers a high-yield dividend and a stable investment opportunity for investors. It boasts a mature business model with investment-grade customers, visible growth in the short, medium, and long term, and low-carbon optionality throughout the business. Enbridge's massive network of pipelines and storage/export facilities and well-diversified cash flows make it a less risky investment than upstream and downstream companies, while its dividend yield of 6.8% is backed by steady and robust free cash flow, consistent dividend growth throughout cycles, and a valuation that makes sense. Enbridge offers a safe and profitable pick for those seeking a balanced yield for dividend growth and high-yield investors.

(Dis)agree? Let me know in the comments!

This article was written by

Disclosure: I/we have a beneficial long position in the shares of XOM, CVX, VLO either through stock ownership, options, or other derivatives. 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 serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.