Enterprise Products Partners: A Core Holding For Any Income Investor (NYSE:EPD) - Seeking Alpha

Enterprise Products Partners: A Core Holding For Any Income Investor (NYSE:EPD) | Seeking Alpha

Enterprise Products Partners: A Core Holding For Any Income Investor
Enterprise Products Partners L.P. (EPD) 35 Comments

Summary

- Enterprise Products Partners has long been a favorite of any investor that is seeking income due to its stable cash flows and high yield.
- The company's contract-based business model allows it to weather any economic conditions, which is nice with all the uncertainty today.
- The company has significant growth potential through at least the end of the decade, as the global demand for fossil fuels will not be going away.
- The company has a very strong balance sheet, but its debt servicing costs will probably go up over the next few years.
- The 7.42% distribution yield is very sustainable and unlikely to be cut.
- This idea was discussed in more depth with members of my private investing community, Energy Profits in Dividends. Learn More »

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Enterprise Products Partners L.P. (NYSE: EPD) is one of the largest midstream partnerships in the United States. It has also long been a favorite of income-focused investors due to its generally stable cash flows and remarkably high distribution yield during most market conditions. Indeed, as of the time of writing, the company's partnership units yield 7.42% despite the fact that the unit price has increased quite a bit year-to-date. As we can see here, Enterprise Products Partners is up 9.08% year-to-date:

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This is despite the fact that West Texas Intermediate crude oil is down 5.80% over the same period. We have seen this same trend with a few other master limited partnerships and midstream corporations over the period though, which I discussed in a previous article. This could be a sign that the market is waking up to the fact that companies like Enterprise Products Partners are not particularly affected by changes in energy prices. It could also be due to the fact that this is one of the few companies available in the market that delivers a higher yield than a typical money market fund, and investors are desperate to secure additional sources of income in order to maintain their standard of living in the face of the highest inflation that we have seen in forty years. Regardless, investors are likely to be pleased with the performance of this company so far this year, and indeed Enterprise Products Partners has long been one of my recommended partnerships in the midstream space. Anyone that wants to buy in has not missed their chance though, as the company still has a lot to recommend it to a buyer today even at the higher price.

About Enterprise Products Partners

As stated in the introduction, Enterprise Products Partners is one of the largest midstream master limited partnerships in the United States. The company owns approximately 50,000 miles of liquids and natural gas pipelines stretching across the United States. It also owns 29 natural gas processing plants, 25 natural gas liquids fractionation trains, and 260 million barrels of liquids storage capacity:

Enterprise Products Partners

One thing that we instantly notice here is that Enterprise Products Partners has operations that stretch to just about every major basin in which crude oil and natural gas are produced. This includes the Marcellus and Utica Shales in Appalachia, which few midstream companies service. This is nice to see because of the inherent diversity that it provides the company. After all, many of these basins have different geologies and therefore different characteristics. For example, the Marcellus Shale is most often targeted by those upstream companies that are looking to produce natural gas, not crude oil producers. In fact, Appalachia produces very little crude oil, as we can see here:

U.S. Energy Information Administration

Thus, production in Appalachia is going to depend much more on natural gas prices and the supply-demand balance for that compound than crude oil. The reverse is true for an area like the Bakken Shale or the Permian Basin, as both of those are primarily oil-producing regions (although the Permian Basin also produces a lot of natural gas). The fact that Enterprise Products Partners has a degree of exposure to all of these different regions and fundamentals thus provides it with a great deal of diversification compared to a smaller peer that only has exposure to one or two hydrocarbon-producing regions.

As mentioned in the introduction, crude oil prices have been down slightly year-to-date. Natural gas is doing much worse, however, as the price of natural gas at Henry Hub is down 43.42% year-to-date:

Business Insider

Ordinarily, we would expect this to affect the unit price of Enterprise Products Partners. After all, as we saw in both 2014 and 2020, the market prices of midstream companies tend to decline alongside crude oil prices. This has also been the case during numerous other periods, such as the second half of 2022. However, we have certainly not seen this so far this year as Enterprise Products Partners is actually up in spite of falling energy prices. This could be a sign that the market has finally begun to realize that the company is not affected very much by changes in crude oil or natural gas prices.

The reason why Enterprise Products Partners is not particularly affected by energy price fluctuations is the business model that the company employs. In short, Enterprise Products Partners enters into long-term contracts with its customers under which the company provides transportation and processing of certain hydrocarbon resources owned by the customer. In exchange, the customer compensates the partnership based on the volume of resources that are handled, not on their value. This provides the company with a great deal of insulation against changes in commodity prices. In addition to this, the contracts that the company has with its customers contain minimum volume commitments that specify a certain minimum volume that must be sent through the company's infrastructure or paid for anyway. This protects the company against production declines that might accompany a fall in energy prices. We are starting to see the importance of this right now as American natural gas producers have been actively working to reduce their production in response to the low-price environment. Overall, this business model provides Enterprise Products Partners with remarkably stable cash flows regardless of energy prices or other macroeconomic conditions. We can clearly see this by looking at the company's adjusted EBITDA (a proxy for pre-tax cash flow) over time:

Enterprise Products Partners

This is a period of time in which energy prices fluctuated significantly. For example, we saw the price of crude oil hit generational lows in 2020. In fact, West Texas Intermediate crude oil actually went negative in April 2020, which is the lowest the price has ever been. Yet, Enterprise Products Partners' cash flows were not really impacted by this event. This is a very nice thing from our perspective as income investors because it provides a great deal of support for the distribution. After all, it is easier for the company to pay out a large proportion of its cash flow to the investors if it can be reasonably certain that it will earn a similar amount of money next year.

Growth Prospects

Naturally, as investors, we are unlikely to be satisfied with mere stability. We like to see a company in which we are invested grow and prosper with the passage of time. Fortunately, Enterprise Products Partners is positioned to do that. As we have already discussed, the company's cash flows directly correlate to the volume of hydrocarbon resources that it transports or otherwise handles using its network of infrastructure. As pipelines, storage facilities, and other midstream infrastructures are only capable of handling a finite quantity of resources, the company must construct new infrastructure if it is to increase the volume of resources that it can handle. It is doing exactly this as it currently has approximately $6.1 billion worth of growth projects under construction that are scheduled to come online between now and the end of 2025:

Enterprise Products Partners

The nicest thing about all of these new projects is that Enterprise Products Partners has already secured contracts from its customers for their use. There are two reasons why this is a very good thing:

- Enterprise Products Partners already knows that the need for the project exists. As such, it can be certain that it is not spending an enormous amount of money to construct infrastructure that nobody wants to use.
- Enterprise Products Partners knows in advance how profitable a given project will be before it spends the money to construct it. As such, it can be certain that the project will deliver a sufficient return to justify the investment.

The partnership has unfortunately not stated exactly how much it expects to make on average from each of these projects. However, it is common for midstream projects to pay for themselves after four to six years, so that is probably a very reasonable estimate here. We can clearly see that the company has a solid pipeline for growth over the next few years.

Enterprise Products Partners is likely to be able to continue its growth for more than just the next two years. Contrary to what the media and Western politicians, the demand for crude oil and natural gas is not going away anytime soon. In fact, the Energy Information Administration projects massive demand growth for both crude oil and natural gas through 2050:

U.S. Energy Information Administration

This growth primarily comes from emerging markets in Asia, as fossil fuel consumption in the United States and Europe is currently projected to peak sometime in the 2030s. However, Enterprise Products Partners can benefit from demand growth anywhere in the world despite the fact that the company itself operates only in the United States. This is because the United States is one of the few areas of the world that can significantly increase its production of crude oil and natural gas in order to meet this demand. This is due to the incredible mineral wealth of areas like the Permian Basin, which is expected to grow its output over the period. As we can see here, Enterprise Products Partners expects that the volume of resources using its infrastructure in the Permian Basin will increase through 2030:

Enterprise Products Partners

This should result in steady cash flow growth for the company due to the fact that its cash flows are directly linked to the volume of resources that it transports. Thus, it makes little sense to avoid investing in the company just because of the constant screams from politicians that fossil fuels will soon be obsolete.

Financial Considerations

It is always important to analyze the way that a company finances its operations before making an investment in it. This is because debt is a riskier way to finance a business than equity because debt must be repaid at maturity. That is normally accomplished by issuing new debt and using the proceeds to repay the existing debt since very few businesses are able to completely pay off their debt with cash as it matures. As the new debt will be issued with an interest rate that corresponds to the market at the time of issuance, this could cause a company's interest expenses to increase following the rollover in certain market conditions. That could be an especially big concern today since interest rates are currently at the highest level that we have seen in more than fifteen years. Thus, any company that rolls over debt today will almost certainly have its interest expenses go up. In addition to interest-rate risk, a company must make regular payments on its debt if it is to remain solvent. As such, an event that causes a company's cash flows to decline could push it into financial distress if it has too much debt. While Enterprise Products Partners does enjoy remarkably stable cash flows over time, this is still a risk that we should not ignore.

The usual metric that we use to judge a midstream company's ability to carry its debt is the leverage ratio, which is also known as the net debt-to-adjusted EBITDA ratio. This ratio basically tells us how many years it would take a company to completely pay off its debt if it were to devote all of its pre-tax cash flow to that task. As of March 31, 2023, Enterprise Products Partners has a leverage ratio of 3.0x based on its trailing twelve-month adjusted EBITDA and net debt as of that date. This is generally an improvement over the past several years, although the company did have a slightly better ratio at the start of the year:

Enterprise Products Partners

Wall Street analysts generally consider anything under 5.0x to be reasonable. However, I am more conservative and like to see this ratio be under 4.0x in order to add a margin of safety to the investment. This is the place where most of the best-financed companies in the industry now reside. As we can clearly see, Enterprise Products Partners clearly meets this stricter requirement. As such, we probably do not have to worry too much about the company's debt load.

We can take further comfort in the fact that Enterprise Products Partners has a staggered maturity schedule. As we can see here, the company does not have an especially large amount of debt maturing during any of the next five years:

Enterprise Products Partners

This is quite nice to see because it means that the company will not have to roll over so much debt during any individual year that the market will not absorb it. This is something that happens on occasion, such as in 2015 and 2020 when the market was generally unwilling to finance any debt issued by companies related to the fossil fuel industry. This is a big reason why many of these companies reduced their distributions and started paying down their debt at those times. We do not know exactly what kind of reaction the market will have to the partnership trying to roll over its debt during any of these given years, so it is nice to see that the company does not have an exceptionally high level of debt that it needs to finance during a specified period.

The big question is going to be where interest rates will fall during any of these years. The Federal Reserve has stated that it will hike rates twice more this year and then hold them there for "an extended period." However, the United States Federal government has a substantial amount of short-term debt rolling over in the near term as a result of the fact that it has been issuing more short-term notes than long-term bonds over the past decade. Thus, high interest rates will rapidly increase the costs to taxpayers of servicing the national debt. In addition, there are numerous signs that the economy will shortly enter a recession, which tends to be politically problematic around national elections. Thus, there is a very real chance that the central bank will lose its nerve and cut rates despite its guidance. However, Enterprise Products Partners currently has average debt servicing costs of 4.6%, and it is highly unlikely that the company will be able to secure rates that low in 2024. Investors should expect the company's interest expenses to increase over the next few years.

Distribution Analysis

One of the biggest reasons why investors purchase units of master limited partnerships is because these companies tend to boast very high yields. This comes from the fact that they normally do not grow at very high rates so they pay out a substantial portion of their cash flows to the investors in order to provide a return that is competitive with other things in the market. The market does not generally assign large multiples to the units of these companies, so the distribution ends up being a substantial percentage of the market price. Enterprise Products Partners is certainly no exception to this as the common units yield 7.42% at the current price. The company has also generally been growing its distribution on an annual basis, but many of its distribution increases have not been especially large:

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The fact that the company grows its distribution with time is something that is very nice to see during inflationary periods such as the one that we are experiencing today. This is because inflation is constantly reducing the number of goods and services that we can purchase with the distribution that the company pays out. Thus, it could feel as though we are getting poorer and poorer with the passage of time. The fact that the company increases the amount that it pays to the investors helps to offset this effect and ensures that the distribution maintains its purchasing power with time. With that said, the company's distribution increases over the past five years were nowhere close to enough to keep up with today's inflation rate, so unitholders have still lost purchasing power.

As is always the case, it is critical that we ensure that the company can actually afford the distributions that it pays out. After all, we do not want to be the victims of a distribution cut that reduces our incomes and almost certainly causes the partnership's unit price to decline.

The usual way that we judge a midstream company's ability to maintain its distribution is by looking at the distributable cash flow. The distributable cash flow is a non-GAAP figure that theoretically tells us the amount of cash that was generated by a company's ordinary operations and is available to be paid out to the limited partners. During the first quarter of 2023, Enterprise Products Partners reported a distributable cash flow of $1.938 billion, which was sufficient to cover the declared distributions 1.80 times over. Wall Street analysts generally consider anything over 1.20x coverage to be reasonable and sustainable. However, I am more conservative and like to see a company's distribution coverage be above 1.30x in order to add a margin of safety to the investment. Enterprise Products Partners easily meets this stricter requirement. Overall, we probably do not have to worry too much about the distribution as this company should be able to easily maintain it.

Conclusion

In conclusion, Enterprise Products Partners has long been a favorite of income-focused investors for some very good reasons. In particular, the company pays out a high yield that is funded by its very stable cash flows. It also has some significant growth potential due to the simple fact that the global demand for fossil fuels is unlikely to go away anytime soon. The company also has a reasonably strong balance sheet, although its debt service costs will probably increase over the next few years. Overall though, this company easily deserves a place in the portfolio of any income-focused investor.

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This article was written by
Energy Profits in Dividends

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This article was originally published to Energy Profits in Dividends on Sunday, July 9, 2023. Subscribers to the service have had since that time to act on it.

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