For midstream firms, it’s all about the cash flows that ultimately drive their steady dividends. And in order to keep those dividends growing, it takes a lot of cash flow ‘boosts.’ Especially when you’re a giant like Enbridge (ENB ). Even building a $2 billion project sometimes won’t cut it and move the needle enough, which is why we’ve seen a ton of M&A activity in both the midstream and the master limited partnership (MLP) sectors.
And ENB’s latest move promises to be a doozy for dividend investors.
At the end of the day, a big-time deal to buy out a big-time rival will only strengthen Enbridge’s appeal for dividend investors going forward and make the firm a kingpin in the world of pipelines.
A Turning Point for Enbridge
In the battle of the Canadian midstream masters, both Enbridge and TransCanada (TRP ) haven’t exactly been firing on all cylinders in recent years. For TransCanada, most of its problems have stemmed from the much-maligned Keystone XL pipeline debacle and its PR problems. For ENB, the issue has been falling oil prices and volumes in its pipelines.
As oil prices have tanked, many producers along its system have cut back or, worse, gone up in smoke. As a result, some analysts have questioned whether volumes at its oil-based pipelines would have enough cash flows to support its hefty dividend. Shares of both ENB and its master limited partnership, Enbridge Energy Partners, L.P (EEP), dropped expectantly.
However, all of that could be changing for ENB with its latest move to boost cash flows.
Enbridge offered an 11% premium to snag up rival Spectra Energy (SE). The deal amounts to over $28 billion in stock and is the largest foreign purchase by a Canadian company ever.
A Midstream Powerhouse
There are plenty of good reasons why ENB would want to sell out that kind of cash and buyout SE. But the biggest reason is simply two words: natural gas.
Spectra is one of North America’s crown jewels when it comes to moving natural gas. The firm features more than 140,000 km worth of natural gas pipelines – a staggering amount of natural gas midstream infrastructure. What is really impressive is that the bulk of those pipelines take gas from the producing regions in the middle of the nation and move it towards the higher-population areas in the northeast. The bulk of its customers are utilities that have a demand-pull need for natural gas, either through gas distribution or electricity generation. This has historically provided Spectra with oodles of gas flow growth in its time.
On the other hand, ENB is one of North America’s largest oil-based pipeline firms. Together they would create a formidable energy powerhouse. One that would own over 30,000 km worth of oil and liquids pipelines: 165,000 km worth of natural gas pipelines, 84 terminals and 415 storage-tank farms. Put another way, the combination of ENB/SE creates the biggest energy pipeline and storage operator in North America. Bigger than Kinder Morgan (KMI ). Bigger than Energy Transfer Equity (ETE). And bigger than rival TransCanada.
Even better is that the combination will be equally focused, in terms of revenues, on natural gas and oil operations. This will help to balance ENB’s cash flows and earnings potential.
The Big-Time Dividend Win
At the end of the day, the buyout was about growing behemoth Enbridge’s cash flows. As we said before, it takes a pretty big boost to do that at a giant firm. This deal certainly does that. Next year, higher cash flows will help ENB see a 15% boost to its dividend, according to management.
The real magic comes over the longer term. Thanks to long-term demand contracts and more than $20 billion worth of already-contracted expansion projects, ENB estimates that it will realize a steady double-digit cash flow growth rate through 2024. The rise in cash flows will trickle down to investors through 10% to 12% annual dividend growth over the next several years, starting in 2018.
Considering that ENB already yields a hefty 4.5%, investors should be pretty pleased with Enbridge’s management right now.
Buying the Pipeline Giant
Enbridge finally figured out how to make itself grow meaningfully. While the buyout will boost its debt load, the combination will pay benefits for its shareholders over the long term. The enhanced product mix, already-contacted expansion projects and demand-pull nature of the new combination will only serve to make ENB a better dividend stock.
Buying either ENB or SE shares to take advantage of the deal makes perfect sense for income seekers. Particularly SE, as investors can catch the few cents difference between the buyout price and its current share price, since the deal will most likely close and be approved by regulators and current shareholders.