Here’s How Enbridge Can Afford its 7.6% Dividend Yield

oil and gas pipeline

Enbridge (TSX:ENB) is one of the highest-yielding, large-cap TSX stocks, with a massive 7.6% dividend yield. If you invest $100,000 in ENB stock, you get $7,600 in cash back each year, assuming the dividend doesn’t change. Historically, Enbridge’s dividend has changed: it has risen! Over the last 10 years, the dividend payout has risen by about 11% per year. In more recent years, the dividend growth has been slower but still impressive.

The question investors need to ask is, “Can Enbridge really afford to pay all these large dividends?” Enbridge’s payout ratio is above 100%. This means that the company pays more in dividends than it earns in profit. Typically, this indicates issues with dividend sustainability. However, Enbridge has an alternative “earnings” measure that it uses to calculate its own payout ratio. Going by that metric, Enbridge’s payout ratio isn’t all that high.

Distributable cash flow

Distributable cash flow (DCF) is an alternative cash flow metric that ENB uses in its earnings releases. It’s somewhat similar to free cash flow, although not the same thing. In Enbridge’s investor day presentation, the company defines DCF, as operating cash flows before changes in operating assets/liabilities, less distributions to preferred shareholders and others, adjusted for infrequent or non-recurring items. Basically, it’s operating cash flows with a few things added back in and a few other things taken out.

Going by distributable cash flow, ENB’s payout ratio is only 72%. That’s somewhat high but not unusually high for a pipeline. The pipeline industry is known for paying a lot of its income to shareholders. The reason has to do with how pipelines operate. Pipelines are much like real estate investment trusts: they lease out infrastructure. This is not an industry with huge amounts of innovation occurring, so it makes sense to simply pay out most of the profit. With that said, pipelines do incur a lot of capital expenditures. It’s for this reason that Enbridge’s dividend payouts ($7 billion if you count both common and preferred) are higher than its free cash flow over the last 12 months ($2.8 billion).

Why the other payout ratios are so high

Despite Enbridge’s DCF payout ratio being reasonable, its earnings and free cash flow payout ratios are high. There are several reasons for this.

First, net income is influenced by depreciation, which, in Enbridge’s case, has been pretty high recently, coming in at $4 billion in the last 12 months.

Second, free cash flow is influenced by capital expenditures (CAPEX), which are also fairly high at Enbridge. The company spent $4.7 billion on CAPEX in the last 12 months, which reduced free cash flow compared to what it would have been without all of the spending.

Enbridge’s CAPEX spending is not likely to decline anytime soon. The company was recently ordered by a U.S. judge to re-route one of its pipelines — that will cost a lot of money. Personally, I think Enbridge is able to pay its dividend for the time being, but another big dividend hike could push the payout ratios into unsustainable territory. Despite the high yield, I am not particularly interested in this stock.

The post Here’s How Enbridge Can Afford its 7.6% Dividend Yield appeared first on The Motley Fool Canada.

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Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy.