Pipeline stocks are often a great way for investors to pick up a lucrative income stream. That's certainly the case at Enbridge (NYSE: ENB) and Buckeye Partners (NYSE: BPL) , which currently have yields of 4.25% and 7%, respectively. However, before investors rush out to buy Buckeye just because of its higher yield, there are a few things worth pointing out that, in my opinion, make Enbridge the better buy.
Battle of the balance sheets
One thing pipeline investors have learned over the past few years is the importance of having a strong enough balance sheet to withstand the storms that often arise in the oil and gas sector. As the following chart shows, both companies have adequate financial foundations:
Current Distribution Coverage Ratio
Data source: Enbridge and Buckeye Partners.
While Buckeye has a lower leverage ratio, its credit rating is at the bottom rung of investment grade, and it has a much tighter distribution coverage ratio. One reason its credit rating is on the border is its history of distributing nearly all of its cash to investors. That practice has come back to bite several of its peers during the recent market downturn, with many having no choice but to cut their payouts so they could finance growth projects or pay down debt. While that doesn't appear to be a concern at Buckeye, it is a risk worth watching.
Meanwhile, Enbridge's leverage is a bit elevated at the moment because the company is working to complete several major expansion projects. However, that leverage ratio is expected to come down as these projects enter service, with Enbridge anticipating that it will fall to 4.3 times by 2019. Adding further strength to the company's financial situation is the fact that it only pays out 50% to 60% of its cash flow in dividends each year, retaining the rest to finance growth projects. In fact, the company currently expects to generate 14 billion Canadian dollars of free cash flow after dividends through 2019, which, along with CA$2 billion in joint venture contributions and CA$8 billion of alternative equity financing, completely supports its ambitious CA$23 billion capex program.
In my opinion, Enbridge has a stronger financial foundation thanks to its higher credit rating, better coverage ratio, and fully funded capital program.
Comparing the portfolios
One area where these companies completely differ is in the makeup of their portfolios. Buckeye Partners is a focused company that primarily transports and stores petroleum products through two segments: Domestic pipelines and terminals and global marine terminals. That said, its assets supply the company with very stable income because more than 95% of its cash flow comes from fee-based contracts.
Enbridge, on the other hand, is a vastly larger company. In fact, once it completes its acquisition of Spectra Energy (NYSE: SE) , it will be the biggest energy infrastructure company in North America by a wide margin. That deal will bolster Enbridge's natural gas exposure, creating a more balanced company focused on both gas and oil to go along with its investments in utilities and renewable power segments. That deal also represents another significant step away from the petroleum market and toward a less carbon-intensive future because it increases the company's exposure to the cleaner-burning natural gas. However, despite its large size, Enbridge still operates a very low-risk business model, with 96% of its cash flow underpinned by fee-based type contracts.
Overall, Enbridge's greater diversity and focus on the cleaner energy sources of the future gives it a clear edge over Buckeye.
A look at the upside
Another major differentiator between these two is their growth potential. Buckeye Partners currently anticipates that it can invest about $280 million to $320 million on organic growth projects per year. Those projects, when combined with its knack for completing accretive acquisitions, should allow the company to continue growing its distribution by $0.0125 per unit each quarter. That represents roughly 1% annual growth from its current distribution of $4.95 per unit each year.
Contrast this with Enbridge, which currently boasts the largest pipeline of energy infrastructure projects in the industry. Overall, the company has CA$26 billion of projects under development and another CA$48 billion of future projects already identified. The company anticipates these projects will fuel 10% to 12% annual dividend growth all the way through 2024.
That's unmatched growth in the pipeline sector, and it gives Enbridge a distinct advantage.
While Buckeye Partners offers investors a higher current yield, that's about all it has on Enbridge. For some investors, that higher yield might be enough of a reason to buy. However, what Enbridge lacks in yield, it more than makes up for in total return potential. Overall, the company expects to deliver double-digit earnings and dividend growth for the next several years, which should fuel mid-teens annual returns for investors. Add to that a strengthening balance sheet and a more diversified portfolio that tilts toward cleaner energy, and Enbridge is clearly the better buy, in my opinion.
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