Enbridge Energy Powers High Yield Opportunity EEP
Enbridge Energy Partners, L.P. (EEP) once again reached painfully into oversold territory for shareholders on Friday February 3rd, when its three day bounce off a precipitous drop from the mid-20s ended.
I want to address the investment thesis of Enbridge Energy, however, before doing so, I think it’s important to discuss the emotion that’s driving the stock price, because all the logic, opportunity, and long-run potential means little or nothing without first understanding what the real price driver has been in the last week, and that same driver known as emotion will likely have an influence in the upcoming short-term first.
The mega-sized decline in value should come as no surprise for investors in the energy space given the volatility in the previous three years. For those unaccustomed to large price movements, especially declines, it’s maybe helpful to understand how the market discounts good and unwelcomed news.
After all, with the stock market averages moving in lock-step one direction, namely UP, it just might be a challenge for some to fully comprehend stocks can and will trade lower. More importantly, for many stocks, especially in a bull market, a price drop means opportunity, not worry or endless despair, but if, and only if you stick with your investing rules.
I can sum it up with the old Wall Street maxim “Stocks take the elevator down, and the stairs up”. The reason is clear, panic is an incredibly strong, albeit often counterfactual motivator and investors routinely dump stocks at the worst possible time.
How do I know? You don’t have to take my word for it, open up a chart on a stock that has capitulated up or down, and you’ll often see a pattern of the highest trading volume very near or at the event. To see an excellent example, look at the June 24th and 26th of last year with the S&P 500 Spider ETF (SPY).
In other words, when the sheep are in panic, the smart money, also called the “strong hands”, buy at a discount from the dumb money, or “weak hands”. It’s a game Wall Street professionals have played forever, and I suspect will continue playing because it’s not about being smart, it’s about emotion.
Which brings us full circle to Enbridge Energy Partners. The catalyst for the drop if you don’t already know if the fear of a lower distribution. At the surface level, it kinda makes sense, after all, who wants to own a stock that’s about to have a dividend/distribution cut? Right?
Wrong, and I will tell you why. What if the price wasn’t $18.28 a share, the closing price on Monday, but rather $2? Is it worth $2? Of course, and if it’s worth $2 and you’re like me and willing to buy all you can at $2, it’s probably worth $3 and so on….
The idea here is there is a valid reasonable price even in the face of a distribution cut that not only is worth buying with both fists, but doing so with confidence and disregard to short-term whims of the dumb money.
Here’s what we know, the forward P/E is anticipated at 30, there’s about 168 million shares in the float, and the last reported short interest was less than 3%.
While a forward P/E of 30 isn’t low except by high flying tech stock standards, it’s well within the moderate to low range for a high-yielding dividend stock.
The 168 million share float means that based on the company’s 2017 numbers, the income is about 92% of the current distribution level. Clearly that’s a problem if the company intends to continue the payout of $0.583 per share, for an eye popping 12.4% annualized.
When a stock has an expected yield of 12.4%, one of two things are likely about to happen. Either the market is slow to understand the value and the price is about to move higher very soon, or the market is discounting an upcoming drop in yield.
Clearly, in Enbridge’s case, it’s the lower forward yield in play, and where you can find value is the fact the market often overshoots moving up and moving lower. The market hates uncertainty, and punishes it greatly. Actually, it’s not the market, but rather the weak hands I mentioned earlier. Weak hands panic and sell, not asking what the real value is, and hence, the sell below what a stock is worth, often after paying more than what it’s worth to begin with. Rinse and repeat, and you understand why the people who work on Wall Street wear the suits they do and drive the cars many others wish they had.
Once again moving back in a logical approach to what management stated, they expect the following (from Enbridge’s 2017 Financial Outlook and Strategic Review Update on 1/27/17)
Following a review of EEP's near-term financial outlook, the Partnership expects to meet its 2016 adjusted EBITDA and Distributable Cash Flow (DCF) guidance of
Management expects 2017 adjusted EBITDA and DCF to be
The fall in Distributable Cash Flow is the highlight, and while other factors including a merger agreement with Midcoast Energy partners didn’t have the best announcement timing, I believe the market is squarely focused on the distribution.
The numbers don’t lie, even if the chart does….
A drop from $860 - $920 million in DCF for 2016 to $750- $800 million for 2017 doesn’t translate into a 50% reduction in distributions. Could, in light of the company’s announcement, investors experience a 40% reduction? I think if one wants to be highly conservative and take a cautious stance, despite the company’s latest numbers suggesting better, an investor could take the current $2.33 annual dividend and reduce it to $1.40.
At $1.40, the yield remains a highly impressive 7.7% for those buying shares at $18.26.
The price doesn’t have to fall much further for the discounted forward yield to push above 8%.
In other words, at this price level, any price movement lower shouldn’t be met with fear, but from a vantage point of thankfulness you’re following this one so you can buy while others are in full blown panic. Blood on the street if you will.
You don’t need me to help you play the what if the dividend/distribution cut is only 30, or 25, or 20 percent game, you can calculate those numbers on your own. But know this, at this time last year, the United States Natural Gas Fund (UNG), the stock I track to follow natural gas, was trading at just about the same price as it is now. In fact, UNG had a slightly lower low in January 2016 compared to 2017. So in my opinion, natural gas prices are relatively stable when compared to last year’s start. Maybe, the downside fear is overblown for natural gas, and I certainly believe it’s the case for EEP.
Speaking of charts, last year, EEP closed January at $18.26, just about the same price as it closed today. By April, it traded above $20, and was able to exceed $26, all while paying the fat dividend. That was with an administration that some may argue isn’t as energy friendly as the current one.
I started buying shares because I understand that even with a yield cut, it’s already priced in, and I believe the market over-shot to the downside.
We may not be at the very bottom, but considering oil is starting out 2017 well above the start of 2016 levels, natural gas is at or above, and we have an administration friendly to business, I think it’s well worth it to add or increase an EEP position now while others find it too “uncomfortable” knowing that EEP’s distributions in 2017, whatever they may be, will make the purchase for those that can remain steady, while others become locked in fear as they stare at the chart very happy.