In Case You're Wrong About Enterprise Products Partners

Summary

• Seeking Alpha contributors have been generally bullish on EPD, including, most recently, Double Dividend Stocks, who called it "the safest high yield in midstream energy".
• Double Dividend Stocks did note one potential risk: a decline in commodity prices.
• In the event that, or a general market downturn, sinks the stock over the next several months, I present two ways longs can limit their risk.
• I also present my site's current take on EPD.
• Members of my private investing community, Bulletproof Investing, receive real-time trade alerts on this idea and many more. Learn more today >>

Enterprise Products outlines its business (image via company video).

Seeking Alpha Contributors Like Enterprise Products

Enterprise Products Partners (NYSE:EPD) has been the subject of bullish articles over the last few months by Seeking Alpha contributors Samuel Smith, Julian Lin, and Dividend Sensei; last week, after EPD's earnings miss, Double Dividend Stocks, operator of the Hidden Dividends Plus service in Seeking Alpha's Marketplace, called EPD "the safest high yield in midstream Enterprise". Double Dividend Stocks did highlight a possible risk for EPD though: a decline in commodity prices that could put pressure on the stock. In case of that, or a general market downturn occurring over the next several months, bellow are a couple of ways longs can limit their risk. Following that, I present my own site's take on EPD.

Adding Downside Protection To EPD

Let's assume, for the sake of these examples, that you own 1,000 shares of EPD and can tolerate a 20% drawdown over the next several months, but not one larger than that. Here are two ways you could protect yourself (the screen captures below are via the Portfolio Armor iPhone app).

Uncapped Upside, Positive Cost

As of Monday's close, these were the optimal, or least expensive, put options to hedge 1,000 shares of EPD against a >20% drop by mid-March.

As you can see above, the cost of this protection was $350, or 1.2% of position value (calculated conservatively, using the ask price of the puts).

Capped Upside, Negative Cost

If you were willing to cap your possible upside at 9%, this was the optimal collar to give you the same level of protection as above over the same time frame.

The put leg in this collar uses the same strike as in the first hedge, so the cost is the same: $350, or 1.2% of position value. But the income generated by selling the call leg was greater than that: $450, or 1.54% of position value (calculated conservatively, using the bid price of the calls).

So the net cost was negative, meaning you would have collected a assuming you placed both trades at the worst ends of their respective spreads.

Now to Portfolio Armor's current take on EPD.

EPD: Passes Both Initial Screens

EPD passes both of Portfolio Armor's two screens to avoid bad investments, plus an additional test. I elaborate below, but first, here are two reasons why you should care about these screens.

Why You Should Care

The first reason you should care about the two preliminary screens is that they can help you avoid stocks that are heading for drawdowns over the next 6 months. On October 9th of last year, for example, I noted that Omega Healthcare Investors (OHI) had failed both preliminary screens and, consequently, was not healthy enough for my system. Here's how OHI performed over the next 6 months, taking into account its dividends.

Sometimes, the names that pass both screens post negative returns too, but, on average, they tend to outperform the ones that fail one or both. I gave some examples of that a couple of years ago ("Guru Picks Gone Bad"):

Guru Picks That Passed Both Screens, 6-Month Returns:

• Advance Auto Parts (AAP), -7.84%
• Precision Castparts, +2.35%
• Cigna Corporation (CI), -2.23%
• Danaher Corp (DHR), +11.55%
• Humana (HUM), -1.28%
• Perigo (PRGO), -23.06%
• Shire (SHPG), -22.85%
• Time Warner (TWC), +10.47%

Average 6-month return: -4.11%

Guru Picks That Didn't Pass, 6-Month Returns:

• SunEdison (SEMI), -39.21%
• SunEdison (SUNE), -86%
• Williams (WMB), -61.12%
• Baker Hughes (BHI), -15.5%
• Office Depot (ODP), -13.74%
• Altera (NASDAQ:ALTR), +7.3%
• Icahn Enterprises (IEP), -7.53%
• Brookdale (BKD), -40.18%
• T-Mobile (TMUS), -12.82%

Average 6-month return: -29.86%

The second reason you should care is that the names that pass these screens with the highest scores tend to outperform the market over the next 6 months, on average. I've been sharing the top 10 names from this ranking with Bulletproof Investing subscribers each week since June 8th of last year, so we have 6-month track records for 35 weekly cohorts as of this week. 28 of them outperformed the SPDR S&P 500 ETF (SPY), and Portfolio Armor's top names averaged returns of 15.62% over the next 6 months, versus 7.71% for SPY.

Portfolio Armor's Current Take On EPD

As you can see in this screen capture from Portfolio Armor's admin panel below, EPD passes both of the site's initial screens.

Here's a close-up of the more relevant columns for our purposes:

Portfolio Armor's first preliminary screen is for the mean of the most recent 6-month return (labeled "Short Term Return" above) and the average 6-month return over the last 10 years ("Long Term Return") to be positive. It is, in EPD's case: it's 9.89%, where it appears under the "6m Exp Return" and "Exp Return" columns.

The second screen is a gauge of options market sentiment. The site attempts to hedge EPD against a greater-than-9% decline over the next several months using an optimal, or least expensive, collar capped at the mean of its short and long-term returns, 9.89%.

Since it passed the 2nd screen without needing to have its cap dropped down from 9.89%, 9.89% appears in the "w/Cap Drop" column. Ordinarily, that would also have been Portfolio Armor's potential return estimate for EPD over the next 6 months. But EPD also passed a third test, in that it was also possible to hedge it against the same >9% decline over the same time frame using optimal puts.

Historically, only about 20% of the securities that pass Portfolio Armor's two preliminary screens pass this "AHP" ("Also Hedgeable with Puts") test, and the ones that do outperform the ones that don't by 37% over the next 6 months. Because of that, the site boosts EPD's potential return by 37%, as you can see in the "w/AHP" column below.

Wrapping Up

Net of hedging cost, EPD's potential return on Monday was 10.1%. By way of comparison, the lowest potential return net of hedging cost among Portfolio Armor's top 10 securities on Monday was about 31%.

So it's unlikely to appear in one of the top 10 names or one of the hedged portfolios I present to subscribers this week. But EPD longs should be encouraged that it passed the two initial screens and the additional AHP test nonetheless, as it suggests, it's more likely to have a positive return over the next 6 months. And if you're concerned about drop in commodities prices or a general market downturn over the next several months, you've got a couple of ways to hedge EPD above.

Analyst’s Disclosure: I/we 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.