Is Enterprise Products Partners Undervalued?

Oct.28.13 | About: Enterprise Products (EPD)

Enterprise Products Partners L.P. (NYSE:EPD) is one of the companies with the ability to generate strong cash flows despite turbulent markets. However, the company's performance was poor in the second quarter of fiscal year 2013 on a standalone basis. I aim to analyze the company's financial records and conduct a deep analysis of its future prospects in order to determine whether or not it is a profitable investment opportunity.

Historical Performance

Business Model

The midstream energy asset network of Enterprise Products connects producers of natural gas and crude oil. The company's assets include 50,000 miles of onshore and offshore pipelines. Moreover, it has 200 MMBbls of storage capacity for natural gas liquids, petrochemicals, crude oil and refined products. Additionally, the company possesses 14 Bcf of natural gas storage capacity. The company's asset portfolio includes 24 processing plants of natural gas, 21 NGL and propylene fractionators.

Business Segments

The five business segments of the company are listed below.

  1. NGL Pipelines & Services
  2. Onshore Natural Gas Pipelines & Services
  3. Onshore Crude Oil Pipelines & Services
  4. Offshore Pipelines & Services
  5. Petrochemical & Refines Products Services

Revenue Mix

As shown in the following chart, the company generated 46.01% of its revenue from the onshore crude oil pipelines and services segment. This segment also made the largest contribution towards total revenues in the second quarter of the current fiscal year. NGL pipeline services made a 31.44% contribution in the total revenues of the company in the quarter that ended 30 June 2012.The three other segments contributed only 22.55% in the revenues during the second quarter of current fiscal year.

Click to enlarge

SOURCE: company financials

Quarterly Comparison

The company's performance deteriorated in the second quarter of fiscal year 2013 in comparison to the corresponding 2012 period. Revenues increased at a slower rate than the increase in cost of revenue. Revenue increased by 13.88% in the second quarter of fiscal year 2013 compared to the 2012 period while the cost of revenue increased by 15.06% in the second quarter of fiscal year 2013. Higher sales volumes primarily drove the increase in revenue and the increase in the cost of revenue.

Gross margin decreased by 95 basis points in the most recent quarter of fiscal year 2013 compared to the quarterly performance of the previous year. Operating expense, as a percentage of revenue, decreased by 3 basis points in the second quarter of fiscal year 2013. However, the impact of a higher cost of revenue trickled down to the operating margin as the operating margins decreased by 93 basis points. This occurred despite the company having lower operating expenses as a percentage of revenues.

Net profit decreased because of higher interest expenses and a higher effective tax rate in the second quarter of the current fiscal year compared with reports of the second quarter of the previous year. The company's net margins decreased by 82 basis points in the second quarter of the current fiscal year compared to reports of fiscal year 2012. Diluted EPS was $0.60 in the second quarter of fiscal year 2013.This was lower than the $0.64 diluted EPS in fiscal year 2012.

SOURCE: Morningstar

Industry Comparison

In some aspects, the company's performance improved and outperformed its peers. Revenue grew with a CAGR of 18.60% over the last three years compared to the industry CAGR of 27.30%. Net revenues increased by a CAGR of 128% compared to the industry CAGR of only 16.60% over the last three years. The company's operating margin was 7.40% which is lower than the industry average of 9.7% in the last 12 months.

SOURCE: Morningstar

The company's ROA was well above the industry average in the trailing 12 months. The debt/equity ratio of the company was 1.2 times which is lower than the industry average of 1.5 times. ROE of the company was 18.9% compared with the industry average of 9.7%. Assets turnover of the company was 1.23 times which is higher than the industry average of 0.61 times. The higher ROE was primarily attributed to higher net margins and the company's assets turnover.

Outlook

According to a report, energy consumption will rise in the long-term because of a growing demand for oil and gas in emerging economies such as China and India. These two economies will grow at a faster pace than any other part of the world. The world GDP will rise by 3.6 percent per annum up until 2040. World energy use is expected to grow by 56 percent over the next three decades. Half of the increase is expected to be driven from China and India.

Due to the increase in supplies of shale gas, natural gas is the fastest growing fossil fuel. According to an Oilfield Equipment and Services report, the US might overtake Saudi Arabia as the world's largest oil producer by the end of 2020.

By 2035, the US could become self-sufficient in terms of energy production. Moreover by 2015, the US could overtake Russia as the largest gas producer. The US oil output increased by 25% over the last 5 years. The IEA estimates that oil output will increase to 30 percent by 2020. Natural gas production in the US surged from 2% to 37% in just a decade. The company provides natural gas processing and related services as well as import and export terminal services. I believe that due to the higher level of natural gas production the company will be able to take advantage of this production and achieve high sales.

Valuation

Base Case

As shown in the following table, the company is undervalued based on its P/E and P/S multiples. However, based on P/CF and P/B, the company is overvalued. By assigning different weights to these multiples, fair value of the stock is calculated at $68.30 which gives a capital return of 7.91%.

Best Case

In the best case scenario, I have assigned 45% weight to P/E and 30% weight to P/S as the company is undervalued on the basis of these multiples. On the basis of these weights, the stock provides an upside potential of 16.22%.

Worse Case

I have assigned more weight to the P/Cash flow and P/B ratios since the company is overvalued on the basis of these multiples. In the worst case scenario, the downside potential of the stock is 14.18%.

Final Call

The company's performance worsened on a standalone basis in the second quarter of fiscal year 2013 in comparison to its performance in the second quarter of fiscal year 2012. However, its performance was satisfactory when compared to industry averages.

In my opinion, the industry has strong growth prospects. Therefore, I believe the company will be able to capitalize on this growth because of its strong performance in comparison to its peers.

According to the multiple-based approach, the stock gives a capital return of 7.91%. Furthermore, its upside potential is 16.22%, which is higher than the downside potential of 14.18%. Therefore, I would recommend buying the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.