Enterprise Products Partners: So how’s the value going? (NYSE:EPD)

On November 16, 2021, I wrote that value will have its day. Enterprise Product Partners (NYSE:EPD) is probably one of the safest income oriented ideas on the stock market. I personally use this particular idea to adjust the risk of my overall portfolio when I go after riskier ideas. This idea had above average profitability for the period, which is very valuable due to the low average risk and very high investment rating.

Most investors report an 8% long-term return on their total portfolio. However, this idea has a total return of about 59% from that article, with almost 30% of that being appreciation. Of course, there is no guarantee of such an outcome in the future. Currently, distribution alone is very close to that 8% average return (as will be shown below).

Since it is well known that “stocks are climbing a wall of worry”, the remarkable sentiment has changed little since all these comments were made. This likely means that this investment idea has more appreciation ahead (and the distribution is likely growing as well). The historically high distribution yield tends to support this idea.

The investment in Enterprise Products Partners seems to have paid for itself well. The reason is that when I wrote that article, the comment section was almost unanimous that the company was not going to grow. Of course, a purchase soon followed which proved to be very encouraging. The acquisition of Navitas Midstream combined with the continued growth of managed products after the coronavirus crisis proved to create a boom year for the partnership when the market least expected it. This acquisition effectively increased the capital budget to a level that the market could not imagine at the time, which produced results that the market never saw coming.

The last article

The last article covered the excellent Q2 results. But guidance for the full year will likely be updated soon with the conclusion of the latest acquisition. The partnership continues to “fire on all cylinders”.

But the industry itself seems to be entering a period where more midstream facilities are needed. Growth is therefore likely to be a more significant part of returns than has been the case in the past. This is a company with significant natural gas exposure that should benefit from expanding North American export capabilities.

Piñon Midstream acquisition

Now comes another unexpected purchase. This will be slightly encouraging before any optimization and assimilation projects add value. On the other hand, this idea promotes the partnership’s presence in the Delaware Basin, where many upstream players have found interesting geology.

As has been typical for many of these acquisitions, the partnership is paying with a combination of cash and debt. The reason the business is bullish is that the profitability of this pipeline should easily exceed the cost of any debt, while also being better than the return the partnership makes on its cash hoard.

A higher return is likely to exist once the assimilation and optimization process is complete.

Increase in distributable cash flow

Investors will love that there will be more money to distribute.

This is a business that can be expanded further. It can be an expansion driven by one or more unlocking projects in addition to obvious capacity expansion projects that require a fair amount of capital.

Hydrogen sulfide and carbon dioxide treatment is a specialty item that has little midstream coverage. But it is just as profitable as other parts of the partnership business.

This is yet another business claiming eligibility for carbon sequestration, which could increase future profits. A secondary issue would be that carbon dioxide can also be used for secondary recovery when these wells become old enough for this to be considered. Should this prove to be the case in the future, the partnership already has a way to sequester carbon dioxide for use in secondary recovery, while qualifying that use for carbon capture (this time by the operator) .

Midstream Assessment

As a Western Midstream (WES) presentation shows, the midstream sector is highly undervalued, despite the fact that the industry is no longer running to the capital market to finance future projects. The market demanded “live within your means”, which resulted in very strong balance sheets and conservative growth.

As the chart above shows, (click for second quarter corporate presentation) despite the industry’s historically lower leverage and self-funding under the “new” model, the industry is now valued less than in the past .

Since the middle part of the industry is often considered to be the utilities of the industry, this would imply a low-risk revaluation going forward.

The management of this company clearly reaches a similar conclusion by comparing the partnership with other aristocrats in various industries. Think of it as a measure of how undervalued oil and gas generally are compared to the broader market.

As the bull market begins to falter and eventually heads into a correction, an underdog like Enterprise Products Partners has a very good chance of riding out any correction.

Even though the current acquisition is related to production, this company has a lot of natural gas businesses that should continue to benefit from North America’s growing ability to export natural gas.

What the current purchase does is still the “just in case” diversification program. As long as the profitability is adequate, it is likely to prove to be a good strategic move.

Summary and evaluation

Enterprise Products Partners has one of the highest debt ratings in the industry. It also has a very long history of growing distributions, which will likely continue with its latest acquisition.

Growth will likely continue through a combination of acquisitions and organic growth. For shareholders, the return to historical midstream industry valuations implies additional potential for appreciation.

EBITDA is running at an annual rate of about $10 billion and there is about $30 billion in outstanding debt. This means that the enterprise value is approximately 9 times EBITDA.

For a partnership of this size, with the consistency shown here, that ratio could easily expand to 15 over time. In the next five years, an expansion of the ratio to at least 12 should be expected.

Earnings are protected by long-term contracts with take-or-pay provisions that limit exposure to downside. In fact, many times the industry has capital projects coming online as the upstream cyclical downturn begins to add to any existing business, which often minimizes or even more than offsets any decline in volumes handled in a downturn.

This means that the industry often has very stable earnings that really do not follow the cyclical nature of the upstream part of the industry. However, common unit or stock prices often follow upstream.

At the moment, there is a concern about too much supply. So the common unit price shown above will probably prove to be a good buying point. Therefore, this is a strong buying consideration that is suitable for a buy-and-hold strategy. However, there is one K-1 issued that any investor should learn all about before investing.

risks

This partnership has a lot of investment grade clients to minimize the risk of bankruptcy in any crisis. This adds to the “steady earnings” story. The partnership has a large stature that can be used to reduce the already low risks of the industry.

This partnership also “stays out of the news”. I follow quite a few companies (or partnerships) that are in the news in a negative way. Those companies also have a valuation to go with all the news exposure. This company appears to have safety programs and personnel to protect itself from adverse press coverage.

There is always the risk that a pipeline or processing plant will go up, despite its impressive safety record to date. Insurance only covers so much in this situation (and you hope it never happens).

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.