By GABRIEL LOWENBERG. Special to The Globe and Mail, Published Thursday, June 11th, 2015.
There are many ways for public companies to prosper. But in my opinion, one of the best is multiple expansion. Let me explain.
Consider Brookfield Asset Management Inc. (BAM), the leviathan that emerged in the late-1990s from the Edper/Brascan empire. Its transformation was hugely complicated but, with the vision of its board and the execution of its CEO Bruce Flatt, it has become a Bay Street darling. From the high single digits, its earnings multiple has climbed to about 15. Inevitably, as the market cap climbed, the dividend yield declined – to just above 1 per cent. A far cry from the 1998 dividend yield of 4.7 per cent.
How did it do this? Simplifying its corporate structure, BAM rolled its assets into sole-purpose public entities, such as Brookfield Infrastructure Partners and Brookfield Energy Partners. In addition, they have moved more heavily into managing other companies’ assets. This strategy has allowed it to earn substantially more revenue from management fees than it did 15 years ago. How much more? The composition of BAM has changed dramatically over the years, so it’s hard to be precise; however, at the end of 2014, it managed $200-billion in assets, of which $89-billion, or 45 per cent, are “fee-bearing capital.” The conclusion is aptly made by the title of its 2014 annual report, which declares BAM a “Global Alternative Asset Management Company” – and it certainly is.
I believe Brookfield’s transformation has not gone unnoticed at Enbridge Inc. Enbridge has three main subsidiaries – Enbridge Energy Partners (EEP-NYSE), Enbridge Income Fund (ENF-TSX), and Enbridge Energy Management LLC (EEQ-NYSE). Enbridge, the parent, has a market cap of $50-billion. Through these public subsidiaries, Enbridge effectively controls each entity with varying percentage ownerships.
Last December, Enbridge management declared its intent to roll more assets into the sole-purpose companies controlled by these entities. Henceforth, the public subsidiaries – not the parent, Enbridge – will issue most of the equity and debt to fund the future capital-expansion projects that they own. Over time, Enbridge Inc. will thus have to issue less equity and debt, and will consequently enjoy more organic earnings growth. This should also lead to higher dividends growth. In the past, Enbridge had issued equity and debt in lockstep with its major capital projects. Now, with the repositioning of assets, the subsidiaries will issue most of the paper.
According to a December, 2014, press release, Enbridge aims to roll more of its $53-billion in property, plant and equipment, or PPE, into the respective Canadian and U.S. subsidiaries. In exchange, Enbridge, the parent, will take back equity and debt paper. But here’s the payoff: The related entities will pay more management fees to the parent than they currently do and thus Enbridge will earn a higher return on the lower capital employed. These management fees constitute the real prize. Hence, the prospect of higher dividend growth in the future. Still, you may fear that Enbridge’s vaults will be empty once it transfers the assets. Not so. Another $44-billion of growth projects are in the “pipeline,” more than replacing the transferred assets.
Enbridge takes its corporate governance very seriously. There is no guarantee that management’s plans will be approved by a majority of independent directors on the respective boards; however, if approved with this transformation, Enbridge will become more like a management company, reaping the benefits of robust management fees, just like BAM. If the market begins to recognize the merit of this approach, Enbridge’s stock price could trade at a 2-per-cent dividend yield over time.
Two important caveats: No oil and gas investment is complete without assessing Alberta’s new provincial government and the looming interest-rate rise planned by the U.S. Federal Reserve. The NDP’s platform proposal – to review royalty and tax rates – will affect all Alberta-based oil and gas companies, as well as the peripheral “food chain” that benefits from production growth. Enbridge is most certainly a target. The second caveat is that, generally, dividend-yielding stocks decline when interest rates go up – unless they can grow their dividends faster. With Enbridge’s planned restructuring, this could be in the cards. In the short term, until the NDP plans are clarified, multiples may well be constrained. But I’m betting on the long term, and have been acquiring Enbridge for clients as its transformation begins to unfold.
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Lowenberg Investment Counsel Inc. (LICi), is an independent wealth-investment management firm based in Ottawa, which owns Enbridge for the benefit of its clients.