Published December 24th, 2016 by Bob Ciura
Master Limited Partnerships, or MLPs, are a haven for income investors. They typically offer yields three to four times the average dividend yield of the S&P 500.
However, the past year has been very difficult for the MLP asset class. The steep drop in oil and gas prices took a massive toll on MLPs, particularly the upstream operators.
Fortunately, well-run midstream operators such as Enterprise Products Partners (EPD) have performed much better.
Enterprise Products has continued to raise its distribution, even in one of the worst downturns for the oil and gas industry in decades.
It is a Dividend Achiever. You can see the entire list of all 273 Dividend Achievers here.
And, it generates more than enough cash flow to sustain its 6% distribution.
This article will provide an overview of the business, and discuss the future outlook for the company.
Business Overview
Enterprise Products is a giant in the midstream MLP industry. It has a massive network of nearly 50,000 miles of pipelines.
Source: Global Mizuho Investor Conference, page 6
The company’s transportation system has capacity for 250 million barrels of NGLs, crude oil, other refined products, and petrochemicals. It can also store 14 billion cubic feet of natural gas.
Source: Global Mizuho Investor Conference, page 7
Enterprise Products has a highly-diversified business model across all sorts of commodity materials.
The business model for Enterprise Products differs from the exploration and production firms. Operating in transportation is typically more stable than production.
The reason for that is because Enterprise Products collects fees based on the volumes it is storing and transporting through its system. While it does suffer to a certain degree when commodity prices fall, demand is a more vital metric than price.
While Enterprise Products will likely not offer as much upside potential as upstream MLPs if oil and gas prices rally, it has less downside as well.
Over the first nine months of 2016, Enterprise Products generated $3.1 billion of distributable cash flow, or DCF. This is a measure of cash flow taken in by an MLP, after operating costs, that shows how much cash flow can be distributed to unitholders.
On a year-over-year basis, this represented a 32% decline from the same nine-month period in 2015.
While this certainly looks bad, the core results were not nearly as bad as they seem. The 2015 nine-month distributable cash flow benefited from a $1.5 billion asset sale. Excluding this, Enterprise Products’ year-over-year performance would be roughly equal.
Growth Prospects
Enterprise Products’ future growth would be boosted by a return to higher commodity prices and economic growth.
Oil prices are still down approximately 50% from their 2014 peak of $100 per barrel. That being said, the rapid decline in active oil rigs has stopped. And, there has been a slight but noticeable pickup in rig activity recently, particularly in premier oil-producing fields such as the Permian Basin.
Source: Wells Fargo Conference, page 8
It will also benefit from growth projects, including internationally.
First, the company has $5.3 billion of growth projects currently under construction. This includes significant projects in the Permian, which has some of the best oil-field economics in the U.S.
Source: Wells Fargo Conference, page 18
The company has a long history of successful growth investments. It has built $36 billion of organic growth projects and conducted another $26 billion in mergers & acquisitions since its IPO.
Separately, international growth is a positive catalyst. The company has seen a flurry of international activity over the past year.
For example, Enterprise Products saw record U.S. LPG exports of 855 MBPD through November. The U.S. has also begun exporting liquefied natural gas to Mexico this year.
According to the company, the U.S. is exporting more natural gas than it imports, for the first time in history. Considering the abundant domestic supply of natural gas, this is a potential gold mine for Enterprise Products.
Distribution Analysis
Of critical importance to income investors is sustainability of the distribution. Investors are right to be skeptical of MLPs, given the carnage that has swept through the industry over the past two years.
It should be understood that there are no guarantees that Enterprise Products’ distribution is secure. But it has at least proven itself capable of handling industry downturns and emerging relatively unscathed.
For example, Enterprise Products has raised its distribution 58 times since its IPO in 1998. It recently raised its distribution by 5.2% year over year. Moreover, it was the 49th consecutive quarterly increase.
Much of this has to do with Enterprise Products’ conservative capitalization. It has a BBB+ credit rating, which is above many other MLPs in its peer group.
When commodity prices decline, pipeline operators’ customers are squeezed. As a result, Enterprise Products has helped itself by building a high-quality customer base.
Source: Global Mizuho Investor Conference, page 8
And, its General Partner has no Incentive Distribution Rights, leaving more cash flow available for unitholder distributions.
The company has averaged a 1.2 distribution coverage ratio throughout 2016. This means that, even with low oil and gas prices, the company still generated 20% more cash flow than it needed for its distributions.
It also has retained $500 million of distributable cash flow this year to buffer the balance sheet. Enterprise Products maintains a 4.5 times debt-to-adjusted EBITDA ratio. This is fairly modest within the MLP peer group.
Source: Global Mizuho Investor Conference, page 45
Enterprise Products’ weighted average cost of capital over the next 10 years is less than 7%. It should be able to generate internal rates of return above this hurdle rate thanks to its attractive growth projects.
Final Thoughts
A 6% yield is hard to find, in a world of low interest rates and rising stock prices. Enterprise Products offers a yield that is three times the average dividend yield of the S&P 500 Index.
While many high yields from the oil and gas MLP space have proven to be risky bets this year, Enterprise Products is a high-quality, best-in-class operator.
The distribution appears secure, which makes the stock an attractive high-yield option for income seekers.
