Investors may be attracted to high-yield oil & gas producers, such as Vermilion Energy (VET, TSX:VET). However, the stock price getting shaved 36% in the past 12 months indicates that there are heightened risks in the juicy yield. A year ago, Vermilion offered a yield of nearly 6%. Today, it offers a whopping yield that’s over 9%!
There may be a place in investors’ portfolios for higher-risk stocks like Vermilion that offer an above-average yield and upside potential at the right price.
However, if that’s not for you, here are two lower-risk dividend stocks that offer safe income because lower oil prices have little impact on their profitability. At the same time, lower oil prices may still trigger some dips in the stocks.
Bank of Nova Scotia
Bank of Nova Scotia (BNS) is one of the Big 5 banks in Canada. Although most of its operations are in oil-producing countries, in which lower oil prices may lead to slower economic growth, the bank’s underlying profitability is much more stable than an oil and gas producer’s.
In fiscal 2018, it reported adjusted earnings of about CAD$8.8 billion, of which 56% came from Canada, 21% came from the Pacific Alliance countries (Mexico, Peru, Chile, and Colombia), and 7% came from the United States.
Source: F.A.S.T. Graphs
As the graph above shows, over the past 20 years or so, Scotiabank had very few dips in adjusted earnings per share (“EPS”). In the last financial crisis that triggered a recession, the bank’s adjusted EPS only fell 6% over a two-year period, which was a small blip.
More recently, from fiscal 2013 to 2018, the international bank increased adjusted EPS by 6.6% per year. Currently, the consensus 3-5 year growth rate is 6.3%, which aligns with the growth rate of +6% in the past five years.
Thanks to Scotiabank’s stable earnings growth over the long run, it has paid a dividend every year since 1833 and has increased its dividend for “43 of the last 45 years, which is one of the most consistent records for dividend growth among major Canadian corporations”, as stated on the bank’s website.
Scotiabank’s 3- and 5-year dividend growth rates are 6.4% and 6.5%, respectively. Its trailing 12-month dividend per share is 7.2% higher than it was a year ago. With a payout ratio of 49% fiscal 2018 earnings, going forward, it’s safe to say that the bank can increase its dividend by 5-6% per year.
Scotiabank’s 4.9% yield + 5-6% growth leads to estimated returns of about 10-11%, without accounting for the fact that the stock is undervalued compared to its long-term normal multiple of about 11.9.
Enbridge (ENB, TSX:ENB) is the largest North American energy infrastructure company by enterprise value, which totals more than US$120 billion. It’s a key part of the North American economy because it transports about 25% and 20%, respectively, of North American crude oil and natural gas, including about 63% of Canadian crude oil exports that go to the United States.
Stable cash flow
Enbridge expects to generate about CAD$13 billion of cash flow this year. The company has very stable cash flow generation with 98% coming from regulated or long-term contracts. That’s why its adjusted cash flow tends to increase. It increased through the last financial crisis and the commodity price collapse. So, its cash flow generation is very predictable and isn’t affected by the volatile prices of the underlying commodities that it transports.
Source: Enbridge May 2019 Investor Presentation (pdf), Slide 5
The company’s key cash flow generation for this year is as follows: about 50% from its liquids pipelines, 30% from gas transmission, and 15% from gas utilities.
Dividend Track Record
Enbridge has an impressive dividend track record for having paid dividends for more than 64 years and increased its dividend per share for 23 consecutive years. Its 3-, 5-, and 10-year dividend growth rates are 13%, 16.3%, and 15.1%, respectively.
In Q1, Enbridge reiterated its 2019 guidance to generate CAD$4.30-4.60 per share of distributable cash flow, which equates to a payout ratio of about 66% for the year. This roughly aligns with the company’s target payout ratio of less than 65%.
Dividend Growth in 2020 and Later
From 2017 to 2020, Enbridge guided to increase dividends per share by 10% annually, and that should result in an annualized payout of about CAD$3.21 per share in 2020, which implies a dividend hike of about 8.6% next year. After 2020, the company estimates distributable cash flow growth of 5-7% per year. So, investors can also expect dividend growth in that range after 2020.
By the time Enbridge closed its acquisition of Spectra Energy in February 2017, Enbridge’s debt-to-cash flow ratio was higher than what investors liked. However, the company has quickly deleveraged to more acceptable levels – a debt-to-cash flow of about 4.7 times by the end of Q1, thanks to non-core assets sales and cash flow generation. The company targets to reduce the ratio to about 4.5 times to further improve the quality of its balance sheet and credit profile.
Source: Enbridge May 2019 Investor Presentation, Slide 10
The following graph shows the time since Enbridge closed the acquisition of Spectra Energy. There was negative sentiment around stock due to Enbridge’s elevated debt levels, but debt reduction has helped lift the stock price.
The table below shows an overview of the company’s capital program for 2019 and beyond. The Line 3 Replacement project makes up about 56% of the $16 billion secured projects. So that’s why the market was negative about the delay of the project, which is now expected to be in service in the second half of 2020. That news has pretty much been digested by the market by now.
Source: Enbridge Q1 2019 Presentation (pdf), Slide 14
Enbridge’s 5.8% yield + 5-7% growth can lead to long-term returns of about 11-13%, without accounting for changes in the multiple.
Higher-yield stocks like Vermilion Energy require a larger appetite for risk from investors. If you know that’s not you, there are more conservative stocks with proven dividend track records that you can consider, including Bank of Nova Scotia and Enbridge. Their yields of about 5-6% are still attractive and can deliver long-term returns of 10% or higher with below-average risk and volatility.
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Disclosure: I am/we are long BNS, ENB, VET. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We’re long all 3 stocks on the TSX. Disclaimer: This article consists of my opinions and is for educational purposes only. Please do your own research and due diligence and consult a financial advisor and or tax professional if necessary before making any investment decisions.