Enterprise Product Partners: Grab Revenue, Stay for Value (NYSE:EPD)


(Note: this article was in the October 11, 2022 newsletter)

Enterprise Products Partners LP (NYSE:EPD) is having an excellent fiscal year. As expected, the value is there while growth is slowing. Of course, the market cycle will continue to move. So the growth will come back in style later. In the meantime, this well-run and undervalued company deserves to be considered a long-term hold.

Company Products Partners Common Unit Price History and Key Valuation Metrics

Enterprise Products Partners Common Unit Price History and Key Valuation Metrics (Seeking Alpha website, October 11, 2022)

Enterprise Products Partners joint units (a K-1 is issued) have all but erased the sharp decline caused by the challenges of fiscal 2020. The current rally in joint unit progress comes as management has developed the business and increased distribution steadily. Even though the company is now bigger than it was when the unit price was higher in the past, the common units have not yet exceeded the pre-covid challenge maximum price. That seems to be about to change.

The midstream business is considered the utility business of the oil and gas industry because companies have long-term contracts with a take-or-pay clause that limits downside participation during low periods. raw material prices. Nonetheless, midstream prices often follow the upstream industry down during a cyclical downturn. This creates an opportunity for the value investor as this company’s earnings will not be impacted by anything close to the degree of upstream producers in a cyclical downturn. Needless to say, midpoint prices often follow the rally upstream as well. So here’s more appreciation in the near future.

The company offers a well-hedged payout yield that roughly matches the amount the average investor earns annually, backed by one of the highest financial strength ratings in the middle part of the investing world. It is one of the few intermediary companies to be rated Investment Grade.

Participation in growth

The partnership surprised the market by making an acquisition at a time when the market thought there would be no growth. This acquisition complemented some minimal capacity expansion products to deliver single-digit growth at a time when the market was not expecting any growth.

Now management has demands for more growth as capacity begins to reach its current limits. But these demands are the start of the usual growth spurt that accompanies upstream during this part of the industry cycle.

Enterprise Products Partners Discussion of Permian Capacity Projections for Natural Gas

Enterprise Product Partners Discussion of Permian Capacity Needs Projections for Natural Gas (Enterprise Product Partners August 16, 2022, Investor Presentation)

Enterprise product partners reduced key leverage ratios during the downward cyclical part of the business cycle while waiting for spare capacity to be utilized. This placed the company in a very flexible position to meet the needs of the continued increase in Permian production projected above. It is one of the few companies that will be able to fund new projects using all debt should management decide to do so, as debt ratios are among the most conservative in the midstream industry. More than likely, management will reinvest some cash flow into debt to maintain a strong balance sheet. This process keeps future financial options open.

This company focuses on the natural gas side of the industry. This has several growth benefits. Ethane, for example, is the raw material for ethylene. Ethylene is used to make plastic which is a much needed material for the green revolution. Thus, this company has a very important stake in the future growth of the green revolution.

Second, natural gas is the feedstock of choice for the growing hydrogen market. It is ironic that hydrogen is considered a renewable resource, but the raw material, natural gas, is not considered renewable. However, it is much easier to separate hydrogen from carbon molecules in natural gas than to separate hydrogen from oxygen molecules in water.

The result is that the demand for natural gas is expected to grow in the coming years. This partnership stands to benefit from this growth with its activity in the Permian Basin. The company also has the technology to transport hydrogen should this market grow. This will happen with the same business practices in place now, so there will be little or no increase in risk.

A big business like this is unlikely to grow faster than decent single-digit amounts over time. But that’s more than enough to provide a combined appreciation and teenage dividend yield for an investment perceived as relatively low-risk with a long history of rising dividends.

Current extension

The partnership has plans for expansion in two ways. These two are acquisition and organic growth.

Company Products Partners Acquired Navitas Pipeline Map

Enterprise Products Partners Map Of Navitas Pipeline Acquired (Enterprise Products Partners August 16, 2022 Investor Presentation)

Management made an all-cash acquisition of a bolted pipeline to expand into an up-and-coming region of Texas. Just when the market was sure there would be no growth, this announcement was made. This propelled the stock higher to anticipate the growth in earnings per share that such an acquisition entails.

This acquisition adds to potential opportunities for organic growth in the future. Even after the acquisition, the partnership retains considerable flexibility as the debt ratios have not changed materially.

Company Products Partners List of ongoing growth projects

Enterprise Products Partners List of Ongoing Growth Projects (Enterprise Products Partners August 16, 2022, Investor Presentation)

The acquisition has already enabled the inclusion of two expansion projects for the Midland Basin. The market was concerned about the low level of capital expenditure compared to the past. But clearly, talks about expanding capacity are heating up. This leads to a market expectation of increased capital spending in the future. Now, the market can see decent growth rates in the single-digit percentage range.

The future

The common shares of the partnership will likely continue to appreciate as the market revises growth forecasts. The Pipeline acquisition has led the market to expect some earnings growth in the current fiscal year, which has not been the case in the past. The individual investor must realize that this management is sufficiently opportunistic to create opportunities where the market does not see any (as demonstrated by this acquisition). Good management tends to surprise on the upside as was the case here.

Now there is more and more talk of a larger takeout capacity being needed. This company also has much-needed capacity in the form of export terminals. All of this and more is causing the market to rethink the “no growth” scenario that has depressed the common unit price for some time.

The common unit return is generous and well hedged. This distribution is also backed by one of the highest financial ratings in the midstream, as it is that rare investment-grade middling. Distribution growth was likely to pick up from the slower pace during the industry downturn. But the long-term average unit growth rate is likely to be single-digit growth. This is the point in the cycle when the highest unit growth rate of distribution occurs.

Yet Mr. Market typically prices these units at a yield of around 5% when the cycle favors income vehicles, because we are getting to that point. This implies a decent amount of upside potential going forward. You rarely see a company in any industry that continually increases distribution every fiscal year. It is one of the few companies to show consistent growth results in a notoriously cyclical industry. These consistent results are likely to continue long into the future to produce a total return in teens.