Enterprise Products Partners LP (EPD) is a leading North American provider of midstream energy services to producers and consumers of natural gas, Natural Gas Liquids ('NGLs'), crude oil, petrochemicals, and refined products, notes Rida Morwa, income expert and editor of High Dividend Opportunities.
The partnership owns over 50,000 miles of pipeline along with natural gas storage capacity and processing facilities, and deep water docks to handle NGLs, Polymer Grade Propylene 'PGP', crude oil, and refined products. Since its inception in 1998, EPD has rewarded investors with growing dividends.
The global pandemic briefly caused shrinking demand and caused investors to flee the oil & gas sector. But being a leader in NGLs and petrochemical products, EPD saw demand soar in the past year.
EPD's story is straightforward. Today, the partnership is highly profitable, produces massive distributable cash flow, and is valued cheaply. We explain in this article the value proposition in EPD in the form of its attractive 8% yield and growth prospects from the shift to a clean energy economy.
While the common unit price has begun to recover from the coronavirus demand destruction scare in Q2 2020, it still trades about 15% below the pre-pandemic levels. The current yield is 8% and is more than the historical average from this quality company. Industry recovery will send the common unit price far higher. This is a rare opportunity for investors to collect an above-average return while waiting for the capital upside.
EPD has a strong involvement in the hydrogen business, a relatively small but rapidly-growing market. Global zero CO2 targets make Hydrogen more attractive as a fuel with potential applications such as long-haul, high-utilization transport fuel, and other industrial applications.
Natural gas and natural gas liquids are seeing booming demand. Despite the impact of Hurricane Ida, EPD's natural gas pipelines transported a record 14.6 TBtus/d for the third quarter of 2021.
EPD alone accounted for more than 1/3rd of all U.S. exports of LPG (liquefied petroleum gases) in the first half of 2021. With prices skyrocketing around the world and countries racing to deal with shortages, there is no end in sight.
NG and NGLs are used to provide electricity, in manufacturing and residential uses. When you plug your car in, where is that electricity coming from? A natural gas powerplant is increasingly becoming the answer.
Some do not realize that many new energy technologies like windmills and solar panels require coatings to lengthen their useful life and ensure durability. In addition to natural gas liquids being a vital raw material for plastic, petrochemicals are important feedstock to several chemicals required to make green revolution products possible.
One of the biggest trends in the automotive sector is reducing the weight of the automobile, so it consumes less energy. Petrochemicals are essential in this transition by supplying plastics that are valuable substitutes to heavier metals like steel.
EPD maintains an "investment grade" rating from both Fitch (BBB+) and Moody's (Baa1). EPD has historically been very cautious with leverage and is recognized for the high-quality underwriting of its loans. As a measure of EBITDA, EPD is the least indebted in the midstream sector.
Additionally, EPD has a very conservative payout ratio and a massive amount of cash flow. For the 12 months ending September 30th, EPD had $5.59 billion in Free Cash Flow after investing a net $2.278 billion back into the business. This means that EPD is fully self-funding.
In fact, over the past year, EPD's total debt ticked down from $30.1 billion to $29.8 billion, while cash on hand increased from $1 billion to $2.2 billion. So EPD reinvested in expansion, reduced debt, paid dividends, and still had $1.2 billion in extra cash added to their bank accounts!
EPD is projecting growth capital expenditures of $1-$1.5 billion in 2022. A pace they will easily be able to fully cover with current cash-flows, or actually was already covered in their cash build-up over the past year!
The third-quarter distribution was covered about 1.6 times. This is considerably higher than peer midstream companies who have been paying out more than their earnings over the past 12 months. With EPD easily paying for all their growth out of cash-flows and still having plenty left over, we expect a healthy dividend raise in Q1 2022.
Not only is EPD's distribution well covered, but it also yields the highest, and the company is valued the cheapest. That is the definition of high-yield at a bargain.
With such strong fundamentals, EPD deserves a premium valuation to the pack. An enterprise valuation of 13-15x annual EBITDA is reasonable as the company returns to historical profitability and growth.
Natural gas is trading at 7-year high levels. The global energy crisis has shown a clear picture of ESG shortcomings. Global demand will persist as the new energy economy will have increased reliance on Natural Gas and NGLs. We already see Trailing-12-Months EBITDA for EPD to be 18% more than 2020.
The discussed tailwinds are set to boost the EBITDA in the next two years. Assuming ~6% growth in EBITDA (assumption consistent with the estimated CAGR for natural gas and NGLs and using a 13-15x EBITDA valuation, we estimate a price target between $32-$37 in the next two years. This implies up to 50% upside from current levels.
Insiders own over 31% of EPD's units. We see continued buying action with minimal selling in the past seven years, indicating management's confidence in EPD's business model and future potential. This high level of insider ownership indicates that management interests are aligned with those of the shareholders.
This bodes well for shareholders as management will do what's best for shareholders with respect to decision-making on capital investments and distributions. For over two decades, this alignment has been a significant contributor to the company's success and value creation for shareholders.
EPD offers valuable infrastructure and energy services that are essential to the United States' accelerated economic recovery. This company's fundamentals are solid. It has excellent attributes:
- An investment-grade credit rating.
- The best management in the industry with long and solid track record.
- A handsome 8% yield with enormous coverage of 1.6x and 22 years of consistent distribution growth.
- A discounted valuation with at least 30-50% upside as the economic recovery continues.
- Remarkably high insider ownership of 31% indicating management interests aligned with shareholders.
- An excellent commodities play to hedge against inflation.
Demand for natural gas and NGLs is set to soar in the upcoming decades. These are the primary growth drivers for EPD's revenues which will result in soaring profitability. Many markets are opening up as new products and new use is becoming apparent to the industry. EPD is the 'Blue Chip' of the midstream sector, and an undervalued high yield gem. It could be the biggest winner in your high-yield retirement portfolio!