Enterprise Products: Dependable Income For Long-Term Security

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About: Enterprise Products Partners L.P. (EPD)
by: Kuhan Puspanathan
Summary

Enterprise Products Partners closed out 2018 with a bang, reporting record earnings and increased investor distribution for 20 consecutive years.

Enterprise continues to leverage its business model to achieve strategic financial and business goals, positioning itself as a leader in the MLP space.

However, in order to be considered for an Income Investment, Enterprise needs to demonstrate the ability to balance the risk/reward profile of its business model.

To be considered for an Income Investment, Enterprise needs to demonstrate the ability generate sufficient cash flow to support the distribution payout.

Correspondingly, can Enterprise continue to generate sufficient cash flow to sustain and grow the distribution payout for the long-term?

This past January, Enterprise Product Partners (EPD) reported a strong close to the FY 2018. A record Total Gross Operating Margin of $7.3 billion led to a record Distributable Cash Flow ("DCF") of $6.0 billion. More importantly, Enterprise was able to achieve its goal of self-funding the equity portion of capital expenditures a year ahead of schedule. This is an important feat as Enterprise was able to maintain its distribution growth policy for 2018 even though it retained a record $2.2 billion of DCF for this initiative.

For those that have been following Enterprise or the MLP sector as a whole would know that these results were not uncommon and speaks to the caliber of the management team. Oil and gas MLPs, including Enterprise gained in prominence and investor confidence - definitely true for this author - alongside the shale revolution. As a midstream energy services company, Enterprise has a unique advantage of being integrated into the midstream value chain.

This profitable business model has enabled Enterprise to grow investor distribution for 20 consecutive years, currently at a 2.5% annual rate. This is definitely advantageous for Income Investors who are looking for investments that maximize returns for the lowest possible risk profile. While hindsight is 20/20, can Enterprise continue delivering on its promise of steady distribution growth for the next 20 years?

Enterprise Integrated Midstream Oil & Gas Value Chain

Source: Investors | Enterprise Products

A Quick Recap: Income Investing

In broad term, it is an investment strategy to maximize cash income from the least riskiest portfolio of investments. For the strategy to work, it is paramount that the asset be able to provide a steady income stream for the foreseeable future. Lacking this confidence would automatically disqualify the investment from being considered for this strategy. A moat-able business model that provides a steady cash flow demonstrates consistency and reliability to income investors.

Unfortunately, another point to consider is the current low-interest rate environment that requires investors to wade in a little more to sustain their income streams. Income investors are now required to consider riskier investments since their trusty steeds - utilities, consumer staples, etc. - are no longer providing enough cover for their income needs.

A Proxy For the U.S. Energy Renaissance

As I have alluded earlier, the shale revolution completely revitalized the energy industry in the US. Enterprise, by integrating itself into the value chain, is able to feel the pull and push of the industry trends. This enables the company to shift gears appropriately and reallocate capital more efficiently.

However, it is important to note that while shale energy is here to stay, the boom period is almost over. Investor giddiness over MLPs is at times being replaced with skepticism and reality checks. Also, many investors were caught unawares by the sudden and unforeseen 2016 crash in oil prices. Due to these negative trends, Enterprise stock price has been trading range-bound for the past 3 years.

Notwithstanding these market conditions, Enterprise has been able to continue raising its distribution payout to investors. Enterprise has been able to achieve this by tying up the majority of its assets to long-term fixed fee contracts with customers. Regardless of market conditions, customers are obligated by their contracts to continue paying Enterprise for the 'right' to utilize its infrastructure and services. This insulates Enterprise from downturns and fluctuating customer demands.

Chart
Data by YCharts

Lets Talk Numbers

Enterprise completed $4.2 billion in growth capital expenditure ("capex") in 2018 and has $5.1 billion worth of projects under construction. For many years, supported by investor appetite for midstream exposure, Enterprise had been able to fund capex through a combination of debt issuance and stock offerings. However, as investor demand waned, it made less sense to issue stock to fund these projects. Therefore, Enterprise decided to retain a portion of its Distributable Cash Flow to fund the equity portion of the investments. Enterprise has been successful in this endeavor without compromising on its distribution schedule to investors.

Enterprise Products Self-funding Goal: Common Units Issuance For The Past 3 Years Source: Investors | Enterprise Products

Furthermore, Enterprise has been able to leverage its business model and capex strategy to grow Gross Operating Margin over the past few years and the growth has been noticeable in every operating segment. Enterprise has been investing heavily in its NGL and Petrochemical businesses, with a particular focus on exports and supplying the domestic petrochemical industry. While there are concerns in regards to the recent tariff battles, demand for energy cannot be quenched so easily around the globe.

Enterprise Products Business Segment Gross Operating Margin For 3 Years Source: Investors | Enterprise Products

Don't Let The Financial Jargon Scare You

A Master Limited Partnership ("MLP") is a type of business venture that offers financial advantages to investors. One key advantage is the requirement for MLPs to distribute the majority of its profits to investors. However, one disadvantage is the tax implications of investing in an MLP. As a Limited Partner, there are tax benefits afforded investors but it comes attached with complex tax filing requirements. Many would run at the very mention of Schedule K-1s unless you are willing to dole out for a tax professional to handle the paperwork come Tax Day.

Another factor that turns investors away is the frequent use of non-GAAP financial metrics. Among others, Total Gross Operating Margin and Distributable Cash Flow. Most energy MLPs including Enterprise operate on a simple premise: get paid for providing energy-related infrastructure and services. However, the capital intensive business model leads management to find creative ways to report earnings and distributions. However, Enterprise has started to make an effort to appeal to more investors by releasing GAAP metrics.

One, with us going more to a self-funding model, we can come in and utilize traditional financial metrics. So a little bit, we're just making that transition from an MLP-centric model, consuming a lot of capital and really trying to appeal to generalist investor. And we need to talk their language, which is GAAP measures, whether it's earnings per unit and price on earnings per unit, whether it's multiple of cash flow from operations or in terms of free cash flow.

Randall Fowler, CFO during the Q4 2018 Quarterly Earnings Call

Conclusion

As an investor, there are numerous reasons to 'buy into' or 'stay away' from Enterprise. The stock price has been stagnating but Enterprise has a resilient business model. This definitely will not be anyone's 'Get Rich Quick' scheme but rather a stable income generator for years to come. In my opinion, Enterprise has proven over time on its ability to continue paying a steady distribution to unit holders. As demonstrated above, the payout is supported by a formidable business model and strategy execution that places Enterprise at the head of the MLP pack. As long as conventional energy is required to power this country, services provided by Enterprise is critical.

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.