Enbridge (TSX:ENB)(NYSE:ENB) stock is a proven long-term winner. Since 1995, investors have accrued double-digit annual returns. The sky-high dividend, now around 8%, is a big reason for that success.
Believe it or not, this business may be facing bankruptcy. The dots are startlingly easy to connect.
A lot of people are blindly trusting Enbridge stock, but you should be cautious.
Here’s the problem
The problem facing Enbridge is the same thing that made it so successful over the decades.
The company is the largest pipeline operator in North America. Its scale is truly impressive. It transports 20% of the continent’s crude oil, plus a lion’s share of the natural gas.
Being big has its advantages. Pipelines are expensive to build. We’re talking a few million dollars per kilometre. High upfront costs require a long operating runway to turn a profit. As the industry giant, Enbridge is capable of sourcing the funding while maintaining the patience for eventual payoff.
When business is good, cash flow is ample. All the company needs to do is transport enough fossil fuels to cover its debt costs (from the initial construction) plus the dividend and any maintenance expenditures.
But if revenue dips, and profits are pressured, the entire business is thrown into chaos. Enbridge has a ton of debt, more than $50 billion worth. When there isn’t enough money to cover the interest costs, equity holders could lose everything.
This doomsday scenario could play itself out over the next few years. BP, one of the world’s largest oil producers, thinks that global oil demand has already peaked. If true, there will be a rush to bring supply to market to avoid sitting on a stranded asset.
Falling demand plus rising supply is a terrible situation for prices. Much of Enbridge’s customer base is already struggling financially. If they go under, that’ll directly impact volumes, and thus profits. It could be a long, painful way down.
Can Enbridge survive?
With a mountain of debt, Enbridge was always playing a risky game. But for decades, industry supply surged. Prices generally moved higher over time, too.
Future conditions may be the exact opposite. Prices could remain low for years to come. That’ll pressure industry supply, as a good chunk of Enbridge’s customer base may be unable to produce profitably.
To be sure, oil demand isn’t going away anytime soon, but that doesn’t mean prices or supply will play nice. That’s bad news if you’re a highly leveraged company that requires high prices and high supply.
The squeeze for cash may have already begun.
Third-quarter earnings came in at $990 million, or $0.49 per share. That’s up slightly from $949 million, or $0.47 per share, the year before. The problem is that dividends alone cost Enbridge $0.81 per share per quarter. Plus it owes dividend payments to preferred shareholders, not to mention interest payments on debt.
Investors might point to the difference between accounting earnings and distributable cash flow, but long term, earnings need to outpace expenses to remain sustainable.
Enbridge is already bleeding cash on some metrics. If conditions continue to deteriorate, it won’t be able to financially support its infrastructure. The business will survive, but the same cannot be said of equity holders.
