Dividends can be a great tool to help create and build wealth over the long-term. Companies that grow dividends consistently have outperformed non-dividend paying companies over the past few decades.
A report by Ned Davis Research showed that S&P 500 companies that grew dividends returned 9.89% since 1972 compared to the 2.39% returns of companies that do not pay dividends. Alternatively, companies that pay dividends but did not grow them consistently returned 7.37% annually.
This outperformance is a clear indication that demonstrates the value of investing in dividend growth stocks. However, investors should note that past history of dividend increases does not matter much. You should instead focus on companies that have the potential to increase future payouts which means identifying and investing in firms with a low payout ratio and growth prospects.
Let’s take a look at one of Canada’s domestic giant Enbridge (TSX:ENB), a company that is valued at a market cap of $78 billion. Enbridge is one of the largest midstream companies in North America and its stock currently has a dividend yield of a tasty 8.4%.
However, does this high yield make it an attractive pick? Here’s all you need to know about this large-cap company.
Enbridge is debt-heavy
Energy companies are capital intensive and pump in billions of dollars to create a robust portfolio of assets that help them generate stable and recurring cash flow. This means Enbridge and peers have to raise debt to fund expansion projects.
One of the key ratios for midstream energy companies is the debt to EBITDA multiple that shows us the company’s ability to service its debt. Enbridge has a debt to EBITDA multiple of 7.1x which is higher than its 5x figure at the start of 2020.
Enbridge has improved its liquidity position due to the COVID-19 pandemic which has increased its leverage ratio. It however it now has a higher ratio compared to peers in the midstream space that are more conservative with a leverage multiple of below 4x.
Is the company’s dividend yield safe?
Enbridge’s forward yield is a big attraction for dividend and income-oriented investors. However, is the company’s yield safe and sustainable amid a tepid demand environment?
Enbridge has paid increased dividends for 25 consecutive years at an annual rate of 11%. However, it managed to do so in a pre-COVID-19 world. In the second quarter of 2020, Enbridge’s distributable cash flow (DCF) was up year-over-year which was in fact one of the worst quarters in history for energy companies.
In the first six months, the company’s dividend payout ratio stood at 64% which is lower than its payout target of 65%. So right now Enbridge’s dividend looks safe and secure. That said, the demand for oil and natural gas has not just declined but fallen off a cliff amid the pandemic.
The global shutdowns and lower consumer spending has decimated oil demand which has forced companies including Enbridge to postpone and reduce capital expenditure for 2020.
However, in the long-term Enbridge is optimistic about energy demand from emerging economies due to a growing population and focus on urbanization. The company has planned projects across all its business segments through 2023 and has set aside $5 billion for the same.
Enbridge expects these projects to increase cash flow by $2.5 billion which will allow it to keep increasing dividends over the next few years.
Enbridge stock has been a solid wealth creator
Enbridge is a pipeline company and pipelines are the cheapest way to move energy. This means energy producers are unlikely to cut back on pipeline use. Further, it is a sector with high entry barriers that enables Enbridge and peers to generate a steady stream of recurring cash flows.
The company generates 98% of cash flows from fee-based or regulated contracts which means it is relatively immune to fluctuations in commodity prices. These factors have allowed the Canadian giant to increase shareholder wealth significantly in the last four decades.
For example, a $1,000 investment in Enbridge stock would have grown to $36,000 today. However, after accounting for dividend reinvestments total returns are close to $150,000. This indicates annual returns of almost 16% compared with the S&P 500 returns of 11% in this period.
Enbridge has successfully managed to develop and acquire pipelines as well as other energy assets that have fueled its dividend growth over the years.
That said, investing in individual stocks carries significant risks. It is always advisable to diversify your portfolio which will lower your risk metrics. You can do so by investing in exchange-traded funds or ETFs.
Several Canadian ETFs have exposure to Enbridge, including the iShares S&P/TSX 60 Index ETF and iShares Canada Select Dividend Index ETF.