- Enterprise Products Partners is an excellent midstream company with a large market presence and a respectable distribution of nearly 6%.
- Over the years, the business has continued to hike the distribution, but the company could likely do more if it wanted.
- With fairly little debt compared to its equity value, and strong cash flows, the firm is in a great financial position.
- Not only is the distribution safe, but investors should expect it to only grow over time.
- Looking for a community to discuss ideas with? Crude Value Insights features a chat room of like-minded investors sharing investing ideas and strategies. Start your free trial today »
One of the more interesting pipeline operators and midstream service providers on the market today is Enterprise Products Partners (NYSE:EPD). With a market capitalization of $63.69 billion, it’s a huge player in the space, plus its yield today amounts to 5.86%, which, though not as high as other pass-through entities investors may invest in, is attractive.
Last week, management decided to raise their distribution yet again, leaving me to question just how high, and for how long, management can continue to grow the payout to shareholders. What I found in my research is that not only is Enterprise’s distribution secured, but it’s possible that, if management wants, it could continue to grow the payout even as the company’s share count soars higher.
A cautionary tale
Enterprise has a long history of growing its distribution. Last week, management announced their 57th consecutive distribution increase and their 66th total quarterly distribution since the business went public in 1998. The rise in the latest quarter wasn’t much, nominally speaking. For the quarter, management declared a distribution of $0.4325 per share, up from the $0.43 per share seen a quarter earlier. On an annualized basis, this implies a distribution of $1.73 per unit. In aggregate, this implies a payout each year of $3.78 billion to the firm’s shareholders.
One way to measure whether a business is paying out too much of its cash toward distributions is to look at its dividend payout ratio. This is calculated as the distribution divided by the firm’s earnings per share. In the graph below, I decided to plot this out for Enterprise for the five years ending in 2017. What it shows looks rather distressing at first glance. According to my figures, Enterprise is paying well above what it is earning each year. Looking at this, investors might conclude that the company will need to cut its distribution at some point or risk pain, but this is where context comes into play.
*Created by Author
You see, according to theory, after adjusting for tax differences that could pop up, a firm’s net earnings and aggregate free cash flow should, over the long run, equal, but I believe the nature of certain long-lived assets and existing depreciation rules can render this not necessarily true. There are plenty of businesses out there, for instance, with fully-depreciated assets on their books, but with value stemming from those assets worth far in excess of zero. It’s in this depreciation veil that we can find long-lasting differences from which cash flow can, in the long run, be greater than earnings suggest.
Cash flow tells a different story
It’s with this mindset that we arrive at operating cash flow. In the graph below, I charted out Enterprise’s operating cash flow per share and its distribution per share. Last year, the company generated operating cash flow of $4.67 billion, the highest it has achieved in at least the past five years. On a per-share basis, this came out to $2.159. Over the same period of time, the company’s distribution per share totaled $1.6825 per share. Unlike in the case of earnings, this implies a payout ratio of just 0.78. Using year-to-date figures, we see a similarly low payout, but of just 0.69.
*Created by Author
Operating cash flow is fine, but to ignore capital expenditures is somewhat ingenuous. I do not believe companies should be punished in this type of analysis for capex that’s allocated toward growth, so I believe that instead of calculating free cash flow as operating cash flow less capex, we should subtract only maintenance capex from operating cash flow to arrive at true free cash flow. Enterprise classifies this not as maintenance capex, but as sustaining capex and, as you can see in the graph below, it has remained fairly consistent over the past five years, while free cash flow has grown.
*Created by Author
After stripping out maintenance capex, we arrive at free cash flow for Enterprise of $4.42 billion for 2017. On a per-share basis, this translates into $2.046. As the graph below illustrates, the distribution payout has been consistently lower than this. Last year’s payout ratio totaled 0.82. This year, so far, free cash flow for Pioneer has come out to $1.171 per share compared to the $0.8575 paid out in the same two quarters. That translates to a payout ratio of 0.73.
*Created by Author
The last metric I wanted to compare Enterprise’s distribution to was the company’s distributable cash flow (aka DCF). Last year, DCF for the business came out to $4.502 billion, the second highest seen in the past five years at least. On a per-share basis, this came out to $2.083, implying a payout ratio for 2017 of 0.81. This year, the company’s DCF of $1.291 per share implies a payout ratio of just 0.66, meaning that Enterprise could, if it so desired, hike its distribution considerably.
*Created by Author
Debt isn’t a problem either
One issue investors should watch out for when it comes to pass-through entities is that they can be prone to becoming overleveraged. Their payout-friendly operating agreements, not to mention their very legal structure as permitted by the government, makes it easy for management teams to borrow large sums of capital and to sometimes even borrow in order to pay out distributions. Conceptually, Enterprise is not immune to this, but it appears as though management has remained committed to financial discipline.
*Created by Author
As the graph above shows, the debt/equity picture for Enterprise has been remarkably flat in recent years. In 2017, the company’s ratio ended at 1.08 compared to the five-year high of 1.12 seen in 2013. Even this year so far, the figure has totaled 1.11, which suggests that management has taken a balanced, long-term-oriented approach to the business’s financial position.
Another alternative here is to wait for its additional projects to come online. In the second quarter of this year, the company allocated $1.1 billion in capex to various projects, and in the third and fourth quarters combined, that figure will be another $1.1 billion. As the projects related to these capex plans come online, cash flow will continue to rise.
Right now, Enterprise is a fantastic business with attractive potential for long-term investors. Not only that, but it has done well in recent years to pay out an attractive and growing distribution. Even with these distribution increases, the business has maintained a fairly low payout ratio relative to operating cash flow, free cash flow, and DCF, which indicates that they could, if they so desired, easily raise the payout for shareholders.
Even with what payouts have been distributed, the company has not seen any meaningful change to its debt ratio in recent years. In order to raise the distribution, the company may have to allow leverage to rise some, but another option is to rely on cash flow that will be generated by projects that will soon come online. Either way, the distribution being paid out by Enterprise is not just safe, it’s low enough that management could probably pay out more in the future if they were so inclined.
A community of oil and natural gas investors with a hankering for the E&P space:
Crude Value Insights is an exclusive community of investors who have a taste for oil and natural gas firms. Our main interest is on cash flow and the value and growth prospects that generate the strongest potential for investors. You get access to a 50+ stock model account, in-depth cash flow analyses of E&P firms, and a Live Chat where members can share their knowledge and experiences with one another. Sign up now and your first two weeks are free!
This article was written by
Daniel is an avid and active professional investor.He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein. Learn more.
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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.