Enbridge Energy Partners Earnings Show Strong 2015 Growth BUT Only High-Risk Dividend Investors Need Apply

Source: Enbridge Energy Partners

Thanks to Wall Street's freak out over the worst oil crash in 50 years even midstream MLPs that reported solid growth in 2015 are getting hammered. Take for instance Enbridge Energy Partners(EEP), and its general partner Enbridge Inc.(ENB 0.87%), which grew by double digits last year.

EEP data by YCharts

However, unlike other quality midstream operators such as Magellan Midstream Partners, Enterprise Products Partners, or Spectra Energy Partners, which the market's pessimism has irrationally placed on sale, Enbridge has earned its much lower valuation.

Let's take a closer look at Enbridge Energy's 2015 results to see just why it remains such a speculative, and high-risk income investment.

Strong 2015 growth BUT...

Source: Enbridge earnings release, Yahoo Finance

Thanks to $2.6 billion worth of organic growth projects placed in service and drop downs from its general partner, Enbridge Energy Partners managed to put up some impressive number in the middle of extremely challenging market conditions.

In fact the MLP reported record liquid volumes of 2.88 million barrels per day or bpd, and is guiding for further 10% to 15% volume growth in 2016. In addition thanks to Enbridge Energy Partners securing $1.9 billion in funding in 2015, and cutting 2016's capital spending budget to just $900 million, management believes it won't need to access equity markets this year.

However, despite this apparently rosy outlook, management also provided guidance that raises some troubling red flags and reveals why Enbridge remains such a high-risk energy investment.

...Enbridge's distribution profile remains dangerously weak AND...

• Yield: 14.7%
• 2016 Coverage Ratio Guidance: 0.8 to 0.9
• Five Year Analyst Payout Growth Projections: 17.5%

Due to rising interest expenses management expects DCF to actually decrease about 6% to $860 million in 2016. Not only does this mean that this year's coverage ratio is likely to weaken to an even more unsustainable 0.85, but it also means that to maintain the current payout Enbridge Energy Partners will need to cover its DCF shortfall by tapping into some of that debt it raised last year.

With energy prices potentially taking several years to recover sufficiently to allow the MLP to profitably access equity markets, Enbridge Energy Partners' will likely have to continue to rely on debt which made up 84% of the capital it raised in 2015, was via debt offerings in order refinance its existing $7.9 billion in total debt, as well as fund further growth over the next few years.

This makes me immensely skeptical that the MLP can achieve analysts' long-term distribution growth targets. That's especially true when you consider what years of low oil prices might mean for the MLP's growth outlook.

...growth prospects are dimming in a world of cheaper energy
One thing Enbridge Energy Partners has going for it is a large drop down pipeline of growth projects that Enbridge Inc. provides. In fact, Enbridge Inc. has eight projects that it could sell to its MLP to provide sufficient DCF growth to increase the coverage ratio and not just secure the existing payout, but potentially allow for its growth as well.

However, with its debt/EBITDA  or leverage ratio increasing from 4.3 to 4.6 in 2015,and rising interest costs already making DCF growth difficult, Enbridge Energy Partners' might not be able to execute on this growth plan. Not unless energy prices strengthen significantly and remain high enough to increase its unit price enough to allow it to raise substantial growth capital via the selling of new units.

This is especially true given the fact that Enbridge Energy has a lot of exposure to Canadian tar sands projects and North Dakota Bakken crude. Canadian tar sands production is much more expensive than traditional oil production, and Western Canadian Select and Bakken oil also sell substantial discounts -- around $13 per barrel and $22 per barrel, respectively -- compared to its West Texas Intermediate counter part which is around $32 per barrel. In fact, Enbridge has already announced that two major oil pipelines meant to serve Canadian tar sands and the Bakken have been postponed until 2019.

Which brings up another concern for Enbridge Energy Partners; the fact that it is likely to face continued challenges growing profitably. This is because the midstream MLP industry is monstrously capital intensive and the MLP's weighted average cost of capital over the past 12 months has been 8.18%, far higher than its return on invested capital  or ROIC, over that time period of just 5.46%.

As Enbridge is forced to take on more and more debt, potentially at higher interest rates, even the projects its scheduled to complete over the next few years may not be enough to preserve the current distribution.  

Bottom line
Unlike many of its higher quality peers, Enbridge Energy's price collapse over the past year doesn't present a good long-term income opportunity. With a highly leveraged balance sheet, overreliance on debt markets that could dry up should energy prices continue falling, and very low ROIC, I question the MLP's ability to grow its way to a sustainable and secure payout.

Therefore any investors considering investing new money into Enbridge need to understand that it represents a highly speculative, short-term, and high-risk bet on a relatively strong and prolonged recovery in oil prices.