2023-05-02 15:03:54 ET
Summary
- Enterprise Products is one of the highest-quality energy midstream companies.
- The company delivered great results during the first quarter.
- Shares are inexpensive and offer a nice dividend yield.
Article Thesis
Enterprise Products Partners L.P. ( EPD ) is a sleep-well-at-night energy midstream pick that combines great management, a fortress balance sheet, a low-risk business model, a high yield, and strong and resilient cash generation.
The company delivered compelling Q1 results, and investors can expect more of the same going forward. In the meantime, between a high yield and an undemanding valuation, EPD could deliver compelling total returns.
What Happened?
Enterprise Products Partners L.P. reported its first-quarter earnings results on Tuesday morning. The company's top-line and bottom-line results can be seen in the following screencap from Seeking Alpha:
Revenues were down a couple of percentage points year over year, missing estimates. But that is not a major problem -- instead, due to the fact that commodity price movements do impact EPD's revenues and its expenses, mostly offsetting each other, the company is not really dependent on generating rising revenues. This was proven again in the first quarter, as EPD's earnings before interest, taxes, depreciation, and amortization (EBITDA) and its distributable cash flows ((DCF)) were both up compared to the previous year's period. And after all, that's what counts for investors -- profits and cash flows decide the company's ability to invest for growth, pay down debt, pay out dividends, and so on.
Enterprise Products beat earnings estimates slightly, but it should be noted that this is not the most important metric for the company. Due to the impact of non-cash charges for depreciation and amortization, net profit does not reflect EPD's ability to pay dividends too well, which is why other metrics such as EBITDA and DCF are more meaningful.
Enterprise Products: King In The Energy Midstream Space
There are many companies in the energy midstream space, some small, some large. Enterprise Products belongs to the largest players in this industry in North America, in terms of market capitalization, enterprise value, EBITDA generation, the total length of its pipeline network, and so on.
But apart from that, it also is one of the highest-quality picks in this space, making EPD the "king" in the midstream space. There are several factors that I consider when attributing a high quality score to EPD.
- First, Enterprise Products has one of the best balance sheets in the industry. At the end of the first quarter, Enterprise Products' net debt position, relative to its trailing twelve months EBITDA, was 3.0. That's perfectly in line with the company's net leverage target. That had been reduced in the recent past, as EPD had targeted a higher net leverage ratio not too long ago. But since its balance sheet kept getting stronger and stronger, and since rising interest rates make debt more costly, all else equal, EPD has recently decided to operate with even less leverage -- despite the fact that its old leverage target had already been rather low compared to the industry average. Many midstream companies operate with leverage ratios of 4.0 or even higher, and due to the generally resilient cash flows that's not a problem. EPD could do so as well, but it doesn't want to -- making it stand out due to its exceptionally low balance sheet risk
- Second, Enterprise Products has a great management team. Many midstream companies have an uneven track record, due to factors such as overspending on growth, ill-timed takeovers, and so on. Peers such as Kinder Morgan ( KMI ) and Energy Transfer ( ET ) have thus experienced tough times over the last decade, although both have turned the corner and look like they are well-positioned for the future. Since EPD has been less aggressive and put more focus on growth spending being accretive for shareholders, it never experienced the problems some of its major peers have experienced. The result is a share price that has been way less volatile compared to peers in the past: EPD's volatility is well below what we see when looking at the volatility in the shares of other large-cap midstream companies, such as ET, KMI, Enbridge ( ENB ), Magellan Midstream ( MMP ), and TC Energy ( TRP ). Volatility is not bad per se, but the fact that EPD's shares are way more stable and less impacted by market volatility and uncertainty speaks for itself, I believe.
- Third, Enterprise Products has one of the best dividend track records in the industry. Enterprise Products has raised its dividend for 25 years in a row, which means that the company hiked its payout in all kinds of macro environments -- during the bursting of the dot.com bubble, during the Great Recession, during the pandemic, during the current energy crisis, and so on. A company that is able to deliver for shareholders no matter what must be doing something right.
EPD is thus, from a business perspective, one of the best midstream companies to invest in, I believe. The results that the company generated during the first quarter strengthen my belief that EPD remains a very high-quality holding.
Enterprise Products' distributable cash flow rose by 5.5% year over year, to $1.9 billion, equal to $7.6 billion annualized. That covers the dividend easily, as EPD's current payout costs the company $4.3 billion a year. The DCF payout ratio is thus 57%, which equates to a coverage ratio of 1.77. Note that distributable cash flows already account for all required maintenance capital expenditures -- if the company decided not to pursue any growth projects, that's the amount of cash that EPD could pay out without accessing debt markets ever again. Due to the proven resilience of EPD's cash flows during all kinds of macro environments, I believe that the dividend is very safe, as excess coverage remains strong.
Even better, even when we account for all the growth spending that EPD has been pursuing (and that will ultimately drive future cash flows, all else equal), the dividend was well-covered. Enterprise Products plans to spend roughly $2.6 billion on growth projects this year, meaning free cash flows (operating cash flows minus maintenance capital expenditures minus growth spending) can be estimated at $5 billion. This covers the dividend easily. EPD should thus be able to spend several hundred million dollars of cash on further debt reduction or unit buybacks this year, even while financing all of its growth investments with 100% cash without using any debt at all -- which is really conservative.
EPD has bought back $300 million worth of units over the last year, which is nice, but not overly impactful, as this is equal to just 0.5% of its market capitalization. But since leverage has now hit the reduced leverage target, it would not be surprising to see EPD pursue buybacks more aggressively going forward -- I personally like that idea, although accretive M&A could also make sense. EPD plans to spend less on organic growth projects next year (~$2.2 billion versus ~$2.6 billion this year), meaning EPD's excess cash flows will likely be even higher next year -- unit buybacks could thus easily rise to more than $1 billion per year in the foreseeable future.
Inexpensive Despite Its Qualities
While Enterprise Products is not the cheapest energy midstream company, it also isn't expensive, despite its strong operational performance and great track record.
Based on the distributable cash flows that EPD generated during Q1, Enterprise Products is currently trading at a DCF yield of 13.3%. This pencils out to a distributable cash flow multiple of just 7.5 and the dividend yield is 7.5% at current prices.
While I do not see any immediate catalyst that could propel EPD's shares up massively in the near term, there is significant upside potential for EPD's shares in the long run, I believe. A 10x distributable cash flow multiple (10% DCF yield) would make for a share price of around $35, which would represent a share price gain of more than 30% versus today. At that price, EPD would still offer a dividend yield of 5.6%, which would be far from bad. When we consider that EPD traded for more than $30 per share before the pandemic, while profits, cash flows, and dividends were considerably lower back then, the $35 share price does not seem unrealistic -- although, again, I don't see a near-term catalyst.
Final Thoughts
EPD is a sleep-well-at-night pick for sure. A great track record, a fortress balance sheet, resilient cash flows, and a safe high-yielding dividend make EPD a strong choice for uncertain times. Shares are inexpensive and have considerable long-term potential, I believe.
For further details see:
Enterprise Products Partners: Ultra Swan Continues To Deliver