Enterprise Products Partners: This 6.3% Dividend Growth Stock Has Another Barn-Burner Year

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About: Enterprise Products Partners L.P (EPD)
by: Rida Morwa
Summary

Enterprise Product Partners just posted Q4 earnings and we see growth across the board. EPD Has A Barn-Burner Year.

The current 6.3% distribution has a very solid coverage of 160%.

EPD has increased its quarterly distribution for 58 consecutive quarters.

With 20 years of dividend hikes, this company is well on its way to becoming a dividend aristocrat.

Co-produced with Long Player and PendragonY for High Dividend Opportunities.

For those who are not familiar with Enterprise Products Partners (EPD), this is one of the largest publicly traded North American midstream company that provides energy services to producers and consumers of natural gas, NGLs, crude oil, refined products and petrochemicals. Their business operates primarily on the United States inland and Intracoastal Waterway systems.

EPD just reported their Q4 earnings results concluding a record year with enviable growth. This midstream company promises to provide income investors with financial security and capital appreciation potential seldom seen in the income sector. Double-digit annual returns from both the distribution and capital appreciation appear assured for the foreseeable future.

Source: Energy Products Partners Fourth Quarter, 2018, Press Release

Rarely does one see the growth per share shown above for the fully diluted earnings per unit when reviewing a normal income investment midstream entity.

  • Earnings per unit increased nearly 50% over the previous year to close a record-breaking performance.
  • Cash flow for the fiscal year increased more than 30% to more than $6 billion.
  • Net income increased by nearly two-thirds to $0.59 per share.
  • Distributable cash flow easily handled the distributions to partner units. The dividend coverage is projected to be 1.6 times. This coverage was far in excess of the market requirements.
  • Management estimates that continuing growth projects can be funded by the reinvested funds for the near future. No dilutive trips to the capital market are needed to fund the growth.

A New Dividend Hike

Management also announced an increase in the distribution of $0.0025 per share for the current quarter and an intent to increase that distribution each quarter in the future by that rate. The goal is to maintain a slightly better than 2% distribution growth rate for the indefinite future. The ample coverage of the current distribution allows such a policy while funding future growth. As long as future growth projects equal or exceed the distribution increase rate, then the distribution growth rate can continue indefinitely into the future.

Cash flows from operating activities increased by about one-third for the fiscal year. The fourth quarter comparison was approximately even with the fourth quarter of 2017. Nevertheless, management has more capital growth projects both contemplated and in-process to keep cash flow growing. Note that the growth projects tend to be large and therefore the cash flow growth will be lumpy. A temporarily flat quarterly cash flow comparison is therefore nothing to be concerned about.

Source: Energy Products Partners December 2018, Investor Presentation

Solid Balance Sheet With No Need For Dilutive Share Increases

EPD has one of the more enviable debt profiles in the industry. The average duration of the debt shown above is nearly 2 decades. This enables the partnership to wait out periods of rising interest rates in order to refinance debt at more attractive levels. Management has managed to lower the debt cost considerably over the last several years. The lower leverage has enabled that borrowing cost-lowering strategy. Notice that nearly half of the debt has a term of at least 30 years.

This is a new trend for midstream companies to avoid raising capital for major new projects by issuing new shares. Historically, what kept the price of the Midstream Sector from rallying is the need to issue new shares to finance new projects, and this is clearly not the case anymore for EPD. A great situation! A high financial rating assures adequate access to the debt markets while the reinvestment of some cash flow funds the equity portion of new projects.

A Massive $2 Billion Share Buyback Announced

Management intends to repurchase shares during times of excellent cash flow. Management just announced a $2 billion buyback. This buyback is enormous and represents a little less than 5% of the current market cap of the units and will be spread over several years. Management intends to purchase units as excess cash becomes available. Like many buyback plans, this plan will be executed depending on market conditions and industry activity levels. It is one more option to return profits to shareholders.

Then when inevitable industry lean times appear, the distribution will not have to be reduced. This is an excellent way to vary the return to the partners without the worry of a distribution reduction. Such a strategy makes the shares appealing to income investors. Another way to accomplish the same strategy would be a year-end special or extra distribution on top of the regular distribution. Management has not mentioned this strategy, but other midstream companies have employed such a strategy in the past.

Dividend History

The reason that we’re so bullish on EPD as an income play is the fact that it offers shareholders a safe high yield with strong growth prospects. Despite strong fundamentals, the midstream sector saw a weak performance in 2018 resulting in some attractive valuations. EPD is yielding 6.3% today. This is more than twice the yield on the U.S. 10-year Treasury, which currently sits at 2.7%. It’s also nearly 3.5x the 1.9% yield that the S&P 500 (SPY) currently provides.

As we mentioned above, EPD is on pace to increase its distributions for the 20th consecutive year. Further showing the reliability of its income growth, it’s worth noting that EPD has increased its quarterly distribution for 58 consecutive quarters. This type of regular, reliable growth doesn’t happen on accident. EPD’s management team prioritizes shareholder returns as well as sustainable business practices that haven’t exposed the dividend nor the balance sheet to excess risk. As noted above, the dividend has a high degree of safety with a coverage of 160% based on cash flows.

What is even more impressive is the returns that long-term investors of EPD have achieved. Investors who bought EPD shares 20 years ago have the dividend yield on the original cost approaching 50% today. Every $1000 invested in EPD at its IPO has produced nearly $6000 of distributions since. It’s no wonder that we like EPD so much!

An Investment Grade Credit Rating

The current BBB rating by management is one of the higher ratings in the industry. The lower financial leverage implies a potential rating upgrade in the future should that lower financial leverage be sustained. Such an upgrade would reassure income investors of the long-term safety of this investment.

A Safe Way To Bank On The U.S. Oil & Gas Boom

The illustration below represents a sample of the growth projects underway. EPD has the financial strength to alter the projects shown quickly materially. EPD cleverly rode the Permian and Eagle Ford boom to higher profits and cash flow. Now this company is well positioned to continue to participate in future above-average growth.

Source: Energy Products Partners December 2018, Investor Presentation

EPD gives the opportunity for investors to bank in a relatively safe way on the continuing oil and gas boom in the Permian and the Eagle Ford. The typical “take or pay” long-term contracts represent a considerable margin of safety over the typical boom or bust of an exploration company. The projected double-digit annual returns represent a relatively safe return that will materially exceed the return of the average investor. This partnership should be a core position for many types of investors because of those returns and low risks.

Source: Energy Products Partners December 2018, Investor Presentation

The company can expand into several other potentially profitable basins. The integration shown in the second slide allows multiple profit opportunities from such expansion. Successful integration allows above average profitability of this partnership and accounts for the above average historical track record.

EPD makes money transporting the gas as well as storing the gas and processing the gas. There is a similar story on the crude oil side.

Valuations

The current enterprise value of the company exceeds $86 billion. Cash flow from operations exceeds $6 billion for the current year. Therefore, this partnership is valued at about 14.5 times the latest cash flow from operations. For a rapidly growing partnership with a decent distribution, this is a fairly cheap valuation. Growth for a partnership this size will inevitably slow. However, double-digit returns from the distribution and the potential appreciation of the units appear very reasonable. The unit pricing was dropped along with the rest of midstream and will probably recover at least 20% as midstream companies come back into favor.

Risks

  • There is always the risk that the past advantages disappear through mismanagement or changing industry conditions. This management has so far managed to stay atop of the midstream industry by several key measures.
  • A sustained slowdown caused by a few years of low natural gas pricing and oil pricing could dim the future prospects of the partnership. The current economic situation makes this highly unlikely because the growing economy should mitigate this prospect.

Overall, this is a large and well-managed company that enjoys well-diversified sources of revenues and high barriers to entry. This is an investment that carries a lower risk given the strength of the business model.

Summary

We’ve viewed EPD as the 'Blue Chip' holding in the MLP/energy space for some time now and the company’s Q4 results have done nothing to change that. This company appears to be firing on all cylinders and the price remains very attractive. The sheer size and financial strength offer a combination of safety for income investors that is one of the best in the industry. The continuing investment in growth projects offers the prospect of capital appreciation that is relatively rare in the midstream industry.

The combination of distribution increases and capital appreciation makes this investment suitable for a wide variety of investors seeking double-digit returns. EPD is a very strong buy at current pricing levels. A combined return of 15% from the distribution and annual appreciation would be a reasonable expectation for the near future. The latest record-breaking results are clearly not reflected in the unit prices. Therefore, there should be some appreciation in the near future to adjust for the latest results.

EPD is unique in offering a safe, high yield of 6.3% with long-term growth prospects. With 20 years of dividend hikes, this company is well on its way to becoming a 'Dividend Aristocrat'. For income investors who do not own EPD yet, buying this stock for the dividends is a solid pick and should strengthen your income stream.

Disclosure: I am/we are long EPD. 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.