In a few years, you'll regret not buying that undervalued high-yield stock

Enbridge (IN B 0.74%) isn't an exciting company, but that's actually one of its biggest draws. That and an ultra-high dividend yield of around 7.4%. But to really understand why you'll be glad you bought this stock in a few years, you need to dig deeper into its business and how it returns value to investors over time.

Enbridge is more than a midstream giant

The energy sector is known for its volatility, but not all companies in the sector deserve that label. Upstream (drilling) and downstream (refining and chemicals) operations are often quite volatile, but midstream companies like Enbridge are generally not. That’s because midstream companies own the energy infrastructure (like pipelines) that connects upstream to downstream and the rest of the world, and they largely charge fees for the use of their assets.

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Enbridge is, in effect, a toll taker. And because oil and natural gas are essential to the smooth running of the world, demand tends to remain strong even when energy prices are low. Oil pipelines account for about 50% of earnings before interest, taxes, depreciation, and amortization (EBITDA), while natural gas pipelines account for about 25%. This is where the next interesting fact about Enbridge comes in.

The remainder of the energy giant's business comes from regulated natural gas utilities (22% of EBITDA) and investments in renewable energy (3%). Natural gas burns cleaner than coal or oil and is considered a transition fuel. Enbridge recently agreed to buy three natural gas utilities from Dominion Energywhich has increased its exposure to this energy niche from 12% to more than 22%. Regulated utilities enjoy a monopoly in the regions they serve in exchange for having rates and investment plans approved by the government. This tends to lead to slow and steady growth over time. In short, Enbridge's business is even more reliable because of this investment.

There's also the renewables business, which is relatively small compared to the rest of the company. But clean energy is a relatively small part of the global energy market. Enbridge's expansion into this business is essentially an attempt to use its fossil fuel profits to evolve with the world as clean energy becomes more important over time. It's a kind of hedge for investors who aren't ready to jump into renewable energy but recognize its growing role in the world.

What can investors expect from Enbridge?

So Enbridge is a boring midstream company that is slowly changing its business in a cleaner direction. It's not exactly a compelling story until you factor in the huge 7.4% dividend yield. Most investors expect the stock market as a whole to generate returns of about 10% per year, so Enbridge's dividend alone gets you about three-quarters of the way there.

That dividend, meanwhile, is backed by a high-quality balance sheet. And the distributable cash flow payout ratio sits right in the middle of management's target range of 60% to 70%. The dividend has also been increased every year for 29 consecutive years. This is a reliable dividend stock, and there's no reason to believe the dividend is in danger. In fact, it seems very likely that slow, steady dividend growth in the low single digits is a reasonable expectation.

So if the dividend grows at about the same rate as inflation, or about 3%, the total return investors can expect is probably about 10%, adding the current yield of over 7% to the dividend increase of about 3%. Normally, stocks grow with their dividends over time to keep the yield constant, so market-like returns for this high-yielding stock are not an unrealistic expectation. It's hard to complain about that, especially if you reinvest your dividends, allowing them to compound over time.

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The base case for Enbridge is good

It seems likely that Enbridge will be able to continue its operations without worrying about the current situation. That will be enough to provide solid returns to investors, as discussed above. But what's interesting here is that Enbridge's dividend yield is historically high today. So it seems like the company is trading at a depressed price.

It’s entirely possible that this situation won’t change and that the yield has simply increased into a new range to reflect Enbridge’s business as it stands today. However, if Wall Street suddenly becomes more interested in the company, investors who buy today will benefit from increased demand for the stock. The base case is that Enbridge’s dull business will produce returns roughly in line with the market, while the upside could be much higher. This seems like an attractive risk/reward tradeoff that you’ll regret missing out on if you don’t jump on board soon.