Enterprise Product Partners (EPD)

Key Statistics

EV/EBIT = 11.27x

Dividend Yield = 11.12%

Earnings Yield = 12.5%

Price/Revenue = 1.23x

Debt/Equity = 117%

The Company

Enterprise Products Partners operates pipelines throughout North America. Their pipeline infrastructure moves natural gas, natural gas liquids, and crude oil. They are the biggest midstream operator in the US, with $29 billion in revenue. The next biggest operator is Kinder Morgan, with $12 billion in revenue.

The heart of their pipeline network is in Texas, where they connect suppliers (like drillers in Texas & shippers in the Gulf) to end-users via their vast pipeline network, which stretches throughout the United States. They also operate storage facilities and processing plants. Currently, they own approximately 50,000 miles of pipelines.

Natural gas and natural gas liquids are core aspects of their operations. Natural gas is critical to US energy needs, supplying 38% of US electricity generation. Natural gas is also essential for heating. The United States boasts the largest supply of natural gas in the world. We are the Saudi Arabia of natural gas.

Natural gas liquids – liquids separated from natural gas as it is processed – are also crucial to the US economy. Natural gas liquids include propane, ethane, and butane. These are critical to our agriculture needs. Additionally, natural gas liquids are inputs in everything from tires to diapers.

Enterprise is like a hub at the center of the energy needs of the United States.

In recent months, traders destroyed the stock and the rest of the energy sector after the COVID energy shock. I think this company’s stock was crushed via guilt by association.

A return to its 52-week high would be an 80% gain from the current price.

My Take

Despite ESG investors’ wishes, hydrocarbons are here to stay for the foreseeable future and are essential to life as we know it.

Without hydrocarbons, life would not be possible as we know it. I think that ESG investors are creating opportunities (via forced selling) for those who are willing to take the plunge into hydrocarbons. ESG investors are behaving like we’ve invented matter/antimatter reactors harnessed by dilithium crystals when no such innovation has actually taken place.

My views caused me to take a hard look at companies in the hydrocarbon sector. I looked at a lot of duds. Highly cyclical (and leveraged) frackers burning cash and going bust at the slightest energy blow up. Even large and respected companies had significant amounts of leverage and dicey track records. I looked at many companies with high dividend yields and wasn’t sure if they could sustain it if the economy rolled over.

Enterprise was different. Enterprise strikes me as the best available opportunity in the energy sector. It’s a fantastic company with substantial advantages and the stock was sold off via guilt by association. In my opinion, it’s a wonderful company at a wonderful price.

The recent decline in energy consumption is temporary. Ten years from now, with modest growth, we will need more natural gas and oil and it doesn’t matter if your ESG fund manager wants it or not.

Enterprise has a formidable moat. No one else is going to spend the money to compete with their vast nationwide network of pipelines. Even if a competitor wanted to match their network, they would need to overcome regulatory hurdles. Every pipeline has to be approved by the government, and no one wants a pipeline in their back yard. Pipelines also benefit from network effects – the more you own, the more valuable your network is. I imagine regulatory approval will grow even more difficult in the future, especially now that “hydrocarbon” is a dirty word. This further insulates them from competitors.

As the biggest midstream pipeline operator in the US, it is also the best managed. This is best demonstrated by a comparison of profit margins. The moat gives it pricing power compared to the next biggest competitors.

Enterprise also establishes contracts with shippers when building a new pipeline, which can be for 15 years or more. They don’t build a new pipeline if the business isn’t already lined up and the existing pipelines have practically guaranteed streams of business.

The fact that no one can duplicate their network and they have long-term contracts with their clients creates a rock solid stream of business. Most importantly, it’s a rock solid stream of business that is resistant to competition.

The company is essentially an energy toll road, and as long as we continue to use natural gas, natural gas liquids, and oil – that toll road will continue to pay dividends.

Speaking of dividends, I was amazed when I looked at Enterprise’s dividend yield. It is currently 11%. I was more amazed when I realized it was sustainable and the company wasn’t employing significant leverage.

Usually, a very high dividend yield is a sign that something is wrong. It’s a sign of massive leverage, a dividend that will be cut, or a melting ice cube of a company. Enterprise is not a melting ice cube. This is a sustainable dividend yield that can continue even if cash flows decline significantly.

The durability of the dividend is best demonstrated by the track record. Enterprise has been able to increase the dividend each year for the last twenty years.

As for other metrics, the P/E is 8, and it trades at 5x cash flow.

Pre-COVID, Enterprise traded for a premium valuation due to its enviable position, strong management team, moat, returns on equity, and cash flow gushing assets. ROE has averaged 16% for the last 10 years. For most of the last ten years, it has usually sold in the 15-25x range, which seems right for a company of this quality. Currently, on an EV/EBIT basis, it trades at 11x.

Enterprise is also in healthy financial condition, with a debt/equity ratio of 117%. This is more than I typically go for (I prefer less than 50% for small caps, and less than 100% for large caps), but it’s conservative compared to the rest of the energy sector. The cash flows that Enterprise generates – even in recessionary years – are more than enough to sustain the company and the dividend.

At current prices, this is an opportunity to buy an 11% dividend yield that is sustainable and likely to grow in the future. The dividend is currently only 52% of EBITDA.

The main risk to Enterprise is a deterioration in the economy, which will reduce the demand of end users. Even if that were to occur, I doubt Enterprise would post actual losses. Even during the Great Recession, Enterprise continued to generate positive operating income with moderate losses in EPS. It continued to stay profitable during the energy bust of 2015-16. In Q2 2020 (the COVID quarter), they still posted earnings per share of $.47, suggesting that they will be able to handle further economic challenges.

In my opinion, this is a unique opportunity to buy a wonderful company at a wonderful price with limited downside risk, the potential for substantial multiple appreciation, and a fat sustainable dividend yield.

Of course, that doesn’t mean that there won’t be more short term pain. It’s possible that we’ll face further troubles in the economy. It’s possible that investors will continue to irrationally sell hydrocarbon stocks (while they sit in a home heated by natural gas, fly around in planes that guzzle fuel, use electricity generated by natural gas, eat food that was made possible by natural gas liquids, and have packages delivered to them via gasoline-powered trucks). There are a lot of short term potential troubles, but I think that this is a safe company to own for the long haul with favorable prospects. Even if pain occurs in the short run, an investor will continue to collect that nice dividend.

Random

Phil at at his best.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.