Enbridge (TSX:ENB) and BCE (TSX:BCE) are trading near 12-month lows after ongoing increases in interest rates triggered a major pullback. Investors seeking passive income are now wondering if ENB stock or BCE stock is oversold and good to buy for a self-directed portfolio focused on top dividend stocks.
Interest rate outlook
The Bank of Canada and the United States Federal Reserve are increasing interest rates to force a slowdown in the economy. The goal is to lower inflation by removing excess demand and loosening up the tight labour market.
It is possible that inflation could remain sticky above the 2% target for some time. This would potentially require additional rate hikes or at least the maintenance of interest rates at current levels for longer than the market previously anticipated.
That being said, there is a risk that the economy could go into a steep decline rather than navigate a soft landing. If things get ugly and unemployment surges, the central banks could be forced to cut rates quickly. Economists have different opinions on when that might occur, with predictions generally ranging from early 2024 to mid-2025.
Impact of high interest rates on dividend stocks
Enbridge and BCE both have large capital programs, and the two companies use debt as part of their funding strategy. As borrowing costs increase, profits can get squeezed. This is one reason the share prices have declined.
Income investors might also be shifting funds to safer investments like Guaranteed Investment Certificates (GICs) that now offer rates above 5% for terms ranging from one year to five years. Stocks carry capital risks, so the market normally adjusts to add a premium on the yield compared to returns offered by fixed-income alternatives. This could be another reason why top dividend stocks have dropped in price and yields have soared.
Enbridge trades near $44.50 at the time of writing compared to $59 at the high point last year.
The stock’s decline appears overdone, considering the stable outlook for revenue growth and the company’s long track record of dividend increases.
Enbridge recently announced a US$14 billion deal to acquire three natural gas utilities in the United States. The purchases add to the existing natural gas distribution business in Canada and will make Enbridge the largest natural gas utility in North America.
The added cash flow, combined with revenue growth driven by the capital program, should support ongoing dividend increases. Enbridge raised the payout in each of the past 28 years. Investors who buy the stock at the current price can get a yield of 8%.
BCE trades for close to $52 at the time of writing. The stock was at $65 earlier this year and topped out around $74 in 2022.
BCE’s media division is struggling with falling ad revenues in the TV and radio businesses. Customers are likely trimming marketing budgets to cover higher debt and wage expenses, and some might be shifting spending to social media platforms.
BCE cut staff this year to adjust to the tough market conditions in the media segment. The core mobile and internet services businesses, however, continue to perform well. BCE expects overall revenue to grow as much as 3% in 2023, and free cash flow should improve as much as 10% compared to 2022. This should provide support for the dividend heading into 2024.
BCE increased the dividend by at least 5% in each of the past 15 years. The stock currently offers investors a 7.4% yield.
Is one a better pick?
Enbridge provides the higher yield right now, so if you only buy one, ENB stock should probably be the first pick for a portfolio focused on passive income. That being said, Enbridge and BCE both look oversold and offer attractive dividends that should continue to grow. Ongoing market volatility should be expected, but I would lean towards splitting a new investment between the two stocks today and look to add to the positions on any additional downside.