Written by Puja Tayal at The Motley Fool Canada
Pipeline stocks have been making a lot of buzz, each for a different reason. The North American energy industry is focusing on natural gas, as it has become the key exporter to European countries after sanctions on Russian oil and gas. Pipeline companies have accelerated work on liquified natural gas (LNG) pipelines. While all companies try to grab a share in the LNG exports market, the question is, between Enbridge (TSX:ENB) and Pembina Pipeline (TSX:PPL), which is a better buy.
Enbridge stock slipped almost 6% on September 6 after it announced the acquisition of Dominion Energy’s three gas utility operations, EOG, Questar, and PSNC, for US$9.4 billion cash. It will also take on US$4.6 billion of debt of the three companies. The acquisition would be accretive to Enbridge’s earnings. Post-acquisition, Enbridge will become North America’s largest natural gas utility company.
While investors reacted bearishly to the deal, it is a strategic move from a long-term perspective. Enbridge has been looking to increase its exposure to gas transmission and utilities. The acquisition will increase natural gas share in the company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to 47% from 40% before the acquisition.
Gas utility is a low-risk business model that generates predictable cash flows and has regulated rates. It fits Enbridge’s low-risk, stable cash flow model of collecting toll money from pipelines. Even after the acquisition, Enbridge aims to maintain its dividend-payout ratio at 60-70% and debt at 4.5-5.0 times its EBITDA.
As for its dividends, Enbridge can maintain its current dividend per share of $3.55 per year, as the company determines its dividends on the previous year’s discounted cash flow. It has not changed its guidance for 2023, which means the company could sustain dividends next year. And once the acquisition is complete in 2024, the combined cash flows of gas utilities and pipelines could grow Enbridge’s EBITDA by 5%. It is slightly lower than its 8% average annual EBITDA growth between 2020 and 2023.
Pembina Pipeline stock
While Enbridge is increasing its exposure to gas utilities, Pembina Pipeline already has diverse revenue streams. It earns 55-60% of its revenue from pipelines in terms of toll fees, 10-20% from oil and gas derivates from marketing and new ventures, and the remaining 25-30% from gas processing facilities. On the fuel front, Pembina earns 60% from LNG and natural gas and 40% from oil. It is a favourable mix, as crude oil is replaced by lower-emission natural gas.
The LNG demand will continue to exist, as they are used for cooking and heating homes during winter. It has grown its revenue in 12 out of 13 years of dividend growth. It has strong fundamentals. But one thing that differentiates Pembina is marketing and new avenues, which makes the former’s stock more volatile.
A better buy: Enbridge or Pembina?
Beta, a measure of volatility, of Enbridge (0.9) is lower than Pembina’s (1.5). If you are a risk-averse investor who hates frequent changes, Enbridge stock is ideal for you. You can lock in a 7.6% dividend yield, which could grow in future.
But if you seek a higher risk, Pembina could give you both growth and dividends. The marketing division opens Pembina stock to commodity price fluctuation, making it relatively more volatile than Enbridge.
While the final decision of which is a better buy is yours, I would prefer Enbridge for its stability. The rising interest rate has weakened the economy and created recessionary fears. In uncertain times, Enbridge stock brings certainty and safeguards the downside risk.
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