Oil & gas stocks will raise passions and attract many investors during bull markets. As the economy grows, demand for such products increase accordingly. Commodity prices go up, profits are skyrocketing, and dividends are generous. The problem is that it rarely stays that way.
The energy sector is the most cyclical of all. If you are courageous enough to ride the roller coaster, you can grab shares at highly depreciated prices every few years. If you would rather stay focused on a dividend growth investing strategy as we do here at DSR, you must be incredibly picky before investing a penny in this sector.
I prefer pipelines (midstream industry) as the most interesting opportunities in the energy sector. Pipelines are capital intensive and exposed to regulators and potential oil spills, but they also act as toll roads. The world needs energy and pipelines are the ones providing it.
Today, we are looking at two Canadian pipeline companies that are offering a high yield combined with a robust dividend growth policy. That’s the perfect combo for any income seeking investors. The best part is that both stocks trade on the NYSE!
TC Energy (TRP / TRP.TO)
Dividend Yield: 5.70%
5-year annualized dividend growth: 9.20%
TC Energy operates natural gas, oil, and power generation assets in Canada and the United States. The firm operates more than 60,000 miles of oil and gas pipelines, more than 650 billion cubic feet of natural gas storage, and about 4,200 megawatts of electric power. TC Energy transports about 25% of natural gas total demand across North America.
Latest Quarter Summary
In July, TC Energy reported a good quarter with double-digit earnings and revenue growth. Once again, TRP demonstrated the resiliency of its business model. Flows and utilization levels across TRP's network continue to be in line with historical norms despite the ongoing impacts of COVID-19, extreme weather events and energy market volatility. Management advances with its $21B capital expenditure program. These investments should support TC Energy's growth for a while and management expects to grow the dividend by 5 to 7% per year. It also announced a partnership with Pembina to jointly develop a carbon transportation and sequestration system in Alberta.
The CEO said:
“During the first half of 2021, our diversified portfolio of critical energy infrastructure assets continued to safely and reliably meet North America's growing demand for energy," said François Poirier, TC Energy’s President and Chief Executive Officer. "Comparable earnings of $2.23 per common share and comparable funds generated from operations of $3.8 billion in the first six months of the year reflect the utility-like nature of our business along with the consistently strong performance of our legacy assets and contributions from projects that entered service in 2020.”
Investment Thesis
TRP is using large amounts of capital to fuel its growth over the coming years. Its acquisition of the Columbia pipeline and its extension toward Mexico are just two examples of what is coming up for TRP. The company will benefit from Mexico’s economic growth (once we get past the coronavirus). TC Energy’s growth is fueled by a $21B capital expenditure budget where most of the money will be invested in what the company does best: natural gas transportation.
While the Keystone XL project has been canceled by the new Biden administration, TRP’s growth potential remains in its natural gas pipeline expansion. TRP is definitely a good candidate for long-term investment. As is the case with Enbridge, you must make sure to track TRP’s rising debt level. The company keeps its focus on rewarding shareholders with generous dividend increases for the coming years.
Potential Risks
Developing new pipelines has never been so challenging, due to the regulations increasing each year. This is for good reason because those companies are one spill away from a major environmental catastrophe. TRP requires a lot of capital to finance its projects. We are starting to worry about their debt levels. Debt is cheap now, but interest rates won’t stay low forever. New pipelines may not be as profitable as expected. Finally, low natural gas prices may slow down Canadian production and eventually negatively affect the pipeline business.
Dividend Growth Perspective
TRP has successfully increased its dividend annually since 2001. TRP shows a 5-year CAGR of 9% and management shows the intention to boost its payout by 5-7% CAGR going forward. We preferred using more conservative dividend growth rates for our DDM calculations. The company growth is fueled by its massive investment program. At the current yield, this is a good candidate for your portfolio.
Enbridge (ENB / ENB.TO)
Dividend Yield: 6.80%
5-year annualized dividend growth: 11.75%
Enbridge owns extensive midstream assets that transport hydrocarbons across the U.S. and Canada. Its pipeline network consists of the Canadian Mainline system, regional oil sands pipelines, and natural gas pipelines. The company also owns and operates a regulated natural gas utility and Canada's largest natural gas distribution company. Finally, the firm has a small renewables portfolio primarily focused on onshore and offshore wind projects.
Latest Quarter Summary
In July, Enbridge reported solid results with distributable cash flow per share up by 4.1%. This leads to a DCF payout ratio of 67.3% for this quarter. Management is confident for the following quarters and reaffirmed guidance to generate 5-7% distributable cash flow growth through 2023. This means more dividend increases for the future. Construction of the final leg of the U.S. Line 3 Replacement Project is progressing on schedule with an expected fourth quarter in-service date. This is great news considering everything that goes around Line 5 since the beginning of the year. ENB continues to progress with the Tunnel Project for Line 5.
The CEO said:
"Following a strong start to the year, our four franchises delivered solid financial performance in the second quarter, with good operating performance and high utilization across our systems. The global economic recovery is now well underway, and our assets have been essential in assuring access to reliable and affordable conventional and renewable energy throughout this critical period. Our performance in the first half of 2021 has set us up well for the full year. We're on track to bring $10 billion of projects into service this year and we're reaffirming our full year 2021 financial guidance."
Investment Thesis
ENB’s customers enter 20-25-year transportation contracts. It is already well positioned to benefit from the Canadian Oil Sands (as its Mainline covers 70% of Canada’s pipeline network). As production grows, the need for ENB’s pipelines remains strong. After the merger with Spectra, about a third of its business model will come from natural gas transportation. Enbridge has a handful of projects on the table or in development. It must deal with regulators notably for their Line 3 and Line 5 projects. Both projects are slowly but surely developing. The cancellation of the Keystone XL pipeline (TC Energy) secures more business for ENB for its liquid pipelines. ENB has now a “greener” focus with their investments in renewable energy. The stock offers a yield over 6% which makes it a strong candidate for any retirement portfolio.
Potential Risks
Stocks do not pay a high yield for nothing. ENB raised its debt and number of shares during the merger with Spectra and the integration of all its partners a few years ago. The total long-term debt stands around $67B since 2017 with no sign of being reduced. It is time we see some debt repayment. As pipelines require significant amounts of capital to build and maintain, ENB may find itself in a position where cash is short. After all, management has plenty of projects to fund, a double-digit dividend growth promises to keep and larger debts to repay. This could seriously jeopardize ENB’s growth plans. Many pipeline projects have been revised or paused by regulators in the past few years. ENB is once again in the middle of a fight for line 5.
Dividend Growth Perspective
The company has been paying dividends for the past 65 years and has 26 consecutive years with an increase. Further dividend growth shouldn’t be as generous as compared to the past 3 years (10%/year). Management aims at distributing 65% of its distributable cash flow leaving enough room for CAPEX. Look for their latest quarterly presentation for their payout ratio calculation. Management expects distributable cash flow growth of 5-7%. Therefore, you can expect a similar dividend growth rate.
To make sure your dividends are safe and that you understand all types of payout ratios, listen to this podcast: Protect Your Dividends: Master All Payout Ratios
