MLPS - Enterprise Products Partners Stock: 3 Reasons Why It Is A Must Own

2023-11-06 06:30:00 ET

Summary

• EPD recently reported Q3 results.
• While its quarter was ho-hum, there were three key points raised on the earnings call that emphasize why it is a must-own stock right now.
• We discuss these reasons in depth.

Enterprise Products Partners ( EPD ) has a phenomenal track record of generating long-term wealth and income growth for investors. Since going public, it has grown its distribution for 25 consecutive years and has delivered total returns that are over five times that of the S&P 500's ( SPY ) over that period:

Moreover, EPD has delivered stellar performance relative to its own sector ( AMLP ), both over the long term as well as in recent years. As EPD management pointed out on their latest earnings call:

We recently did a comparison of the six largest North American midstream energy companies, those with a market capitalization over $35 billion. Since 2019, EPD is one of only two companies to have actually reduced common unit/share count and we are the only midstream company to reduce unit count over this time period without material asset sales. EPD reduced its common unit count by approximately 1% over this period, as did our peer. While this is a modest start, it is a consistent start of buybacks for six years in a row. We were also one of only three companies that grew distributable cash flow per unit by 15% or more, in fact, for this group of six midstream energy companies, DPD is the only company to have both reduced unit count and increased DCF per unit.

In this article, we discuss three reasons why EPD is a must-own stock right now.

#1. Pristine Balance Sheet

Given how dramatically interest rates have risen since the beginning of 2022, balance sheet strength is of utmost importance right now. Many businesses are having to slash growth guidance - or even cut their dividends - in order to address significant debt maturities that will have to be refinanced at interest rates that are far higher than what they were paying previously. However, EPD has little to nothing to worry about on this front.

The weighted average term to maturity on their debt is a whopping 19 years and 96% of their debt is at fixed interest rates. Next year, only 3% of their term debt matures and only 13% of their term debt matures through 2026. When combined with their billions of dollars in retained cash flow every year net of distributions, EPD is very resistant to rising interest rates and should face little to no headwind to its bottom line from the current elevated interest rate environment.

Moreover, to the degree that higher interest rates open up opportunities in the M&A marketplace or even in their own unit price, EPD is in a very strong position to take advantage of it. As of the end of Q3, their consolidated liquidity was approximately $3.8 billion, they had a consolidated leverage ratio of 3.0x (one of the lowest in the midstream sector), boasted an industry-best A- credit rating, and had plenty of room within their 3.25x target leverage ratio upper limit. As a result, they are in a position to invest opportunistically, whether via buybacks, acquisitions, or organic growth projects. Investors in EPD units can truly sleep well at night knowing that it has a fortress balance sheet that is prepared to weather whatever storms may be coming its way.

#2. Resilient Business Model

Another reason why EPD is a must-own investment right now is that the economy appears increasingly likely to be headed for a downturn, and potentially a severe one at that. As a recent article from Forbes lays out , potential shocks from an auto strike, the resumption of student loan repayments, the possibility of a government shutdown in the coming months, the depletion of pandemic savings, elevated interest rates, and elevated energy prices are exerting pressure on the economy. Moreover, Bloomberg Economics' analysis suggests that there is a high probability that the National Bureau of Economic Research will declare a recession starting in late 2023, and there are growing geopolitical risks that could also deal a severe blow to the economy should they manifest into actual major events.

Looking at EPD, we see a business that has generated very consistent cash flows even during severe conditions for the energy industry and the broader global economy as well. As the charts below illustrate, EPD continued to generate double-digit returns on invested capital even during the energy market crash in 2018 as well as during the worst energy industry and broader macro-economic conditions in a very long time in 2020:

Even this past quarter - despite dealing with weather and natural gas price headwinds - EPD still churned out a very solid performance, including covering their distribution by 1.7x.

#3. Accelerating Capital Returns

The third, but perhaps most exciting, reason why EPD is a must-own investment right now is become EPD appears to be on the cusp of materially accelerating its unit buybacks and/or distributions. Management emphasized its buyback program repeatedly throughout its earnings call and implied that - once its major investments are completed (mostly by the end of 2024) - it will be in a position to materially increase buybacks and/or distributions in the years following. This is due to three factors:

1. Their current growth investments are sucking up a lot of their cash flow, thereby significantly reducing EPD's free cash flow. Once these projects roll off of the capital expenditure budget, EPD will then add these CapEx dollars to their free cash flow.
2. Once these projects come online, they will begin throwing off significant cash flow as well, further increasing EPD's free cash flow generation.
3. These projects will also be generating significant EBITDA, thereby reducing EPD's leverage ratio meaningfully (since the leverage ratio is calculated as net debt divided by EBITDA). This will in turn create additional capacity on their balance sheet, enabling them to return additional cash to unitholders.

Management seemed to set the stage for accelerating buybacks in the coming years by referring to its recent buybacks as a "start" on the earnings call:

While this is a modest start, it is a consistent start of buybacks for six years in a row.

Moreover, they highlighted the pathway to increased distributions and buybacks when they stated:

once you get out [to] 2025, 2026, 2027, we ought to be throwing off a good bit of free cash flow...we don't see the need to come in and reduce leverage anymore from where we are today...that provides more cash for distribution growth and buybacks.

For a partnership that is already generating a high single-digit capital return yield to unitholders along with a 5%+ annualized distribution growth rate in recent years, a material acceleration of these capital returns beginning in 2025 could mean a meaningful spike in the unit price at that point. At a minimum, it means that the current distribution is even safer than the 1.7x coverage ratio, A- credit rating, and defensive business model already imply.

Investor Takeaway

With interest rates at levels not seen since the beginning of the millennium and recession concerns growing, sleep-well-at-night, defensive, and high-yield dividend growth stocks are very attractive right now. However, when you combine those strengths with the potential for material acceleration of capital returns within 1-2 years and a very reasonable valuation right now, you get the potential for exceptional risk-adjusted returns. As a result, we view EPD as a must-own investment right now.

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