Where Will Enterprise Products Partners Stock Be In 5 Years? Former Bear Upgrades The Stock

Summary

• Enterprise Products Partners has surged 22% since I sold the stock.
• Yet in spite of that strong performance, I am upgrading my view to a buy rating.
• The strong commodity pricing environment may help improve the credit profile of its customers.
• The stock yields 7.2% and is now fully covered by free cash flow.
• Looking for a portfolio of ideas like this one? Members of Best Of Breed get exclusive access to our model portfolio. Learn More »

imaginima/iStock via Getty Images

Enterprise Products Partners (NYSE:EPD) has not seen its stock soar like many other energy stocks because it does not have the same torque to higher energy prices. Yet in exchange, the company provides greater stability due to its fee-based cash flows. With energy prices stabilizing at high levels, I expect EPD’s customers to improve in terms of credit quality, which bolsters the investment case for EPD stock. With EPD yielding around 7.2%, the stock could prove to be a great addition to income-seeking portfolios.

EPD Stock Price

Many investors considered EPD to be very cheap prior to the pandemic and the stock still trades lower than those levels. In fact, the stock trades at the same levels it did over 10 years ago.

Data by YCharts

Since I last wrote about the company in April of 2021, the stock has delivered 22% total returns, outpacing the 8.3% return of the broader market. In spite of the outperformance, I am switching gears and rating the stock a buy. At the time, I viewed the stock as offering a poor risk-reward proposition as the 8% yield did not look like enough to compensate for the credit quality risk of its customers. But with energy prices having rebounded to multi-year highs, there is high potential that the energy sector will emerge with far stronger credit metrics than before, as energy companies appear to be focused on balancing rewarding shareholders with deleveraging their balance sheets. Furthermore, EPD has rapidly scaled back its growth capital expenditure outlook, which has suddenly made its distribution fully covered even after accounting for capital expenditures. As a result, it makes sense to bump the stock to a buy rating even though I had sold at lower levels.

EPD Stock Key Metrics

I won’t rehash the general story for EPD - you can see my previous article for a more in-depth description of the business model. Instead, I’ll focus on the key metrics to look at for this stock.

The most important metric is that of leverage. Debt to EBITDA stood at 3.1x as of the end of 2021, and the company had a BBB+ rated balance sheet. Compare this with the roughly 4x debt to EBITDA ratio at popular peer Energy Transfer (ET). Most investors likely understand that less leverage means lower risk. But in the midstream sector, leverage means much more than that. Leverage is the easiest metric to track management strength. Because midstream companies typically grow by building out new projects, the leverage ratio is a strong indicator of the company’s history of execution. A low leverage ratio typically means that the company has historically realized strong returns on investment. A high leverage ratio typically means that the company has historically underperformed expected returns on investment. EPD’s best-in-class leverage ratio is a testament to management’s ability to deliver on projected returns.

Besides the low leverage ratio, 2021 was a historic year in which the company was able to self-fund its capital expenditures.

EPD 2021 Q4 Presentation

What does this mean? Investors typically measure total distributions paid out versus free cash flow, which is defined as distributable cash flow subtracted by all capital expenditures. EPD spent $1.8 billion on growth capital expenditures in 2021, down significantly from $3 billion in the prior year. EPD had previously guided to $1.6 billion of growth capital expenditures in 2021. In 2021, EPD earned $6.6 billion in DCF and paid out $3.9 billion in distributions. The company was able to even reduce net leverage by over $2 billion in the year.

I note that the lack of self-funded capital expenditures was not necessarily a negative. I just mentioned that EPD historically realized strong returns on growth projects - that would suggest that using debt to fund growth projects should be encouraged by investors. Yet with new pipeline projects being largely restricted by Washington, the company suddenly is simply unable to fund new projects even if it wanted to. This may reduce the company’s ability to fund future growth, but my view is that the greater free cash flow coverage of the distribution will create greater unitholder value through multiple expansion. The benefits from the lower perceived risk should outpace the slower growth.

EPD spent $214 million on unit repurchases - a nominal amount but significant considering that the company has a limited history of unit buybacks. I am hopeful that the company will increase its love of unit repurchases as that in my opinion is the quickest avenue for multiple expansion. Looking forward, EPD has guided for $1.5 billion of growth capital expenditures and $1.85 billion of total capital expenditures in 2022.

EPD 2021 Q4 Presentation

As stated on the conference call, the $1.5 billion in forecasted growth capital expenditures includes any capex related to its recently closed Navitas acquisition. This suggests that EPD should fully cover its distribution yet again in 2022.

In regards to the 3.1x debt to EBITDA ratio, I expect leverage to tick up this year. This is because the company funded its recently closed acquisition of Navitas Midstream with $3.25 billion of cash and debt.

Navitas Acquisition Presentation

That increased EPD’s net debt by just under 10%, but leverage shouldn’t increase by that amount because Navitas was flowing cash already. The acquisition does show that the company will likely prioritize external acquisitions over share repurchases, which is understandable considering that it won’t be able to spend so much on growth capital expenditures. It is possible that investors may need to start including cash spent on acquisitions in their definitions of free cash flow moving forward, especially if EPD becomes a habitual acquirer of assets.

Is Enterprise Products Expected To Grow?

Over the coming years, EPD is expected to show modest growth. This makes sense because EPD primarily generates fee-based cash flows, which do not have direct torque to higher energy prices.

Seeking Alpha

EPD has guided for the Navitas acquisition to lead to incremental gains of $0.18 to $0.22 per unit in 2023.

Where Will EPD Stock Be In 5 Years?

In 5 years, I expect EPD to trade modestly higher from here, though not necessarily by so much. Those gains would be driven by an improving macro picture for the energy sector. In particular, the Russian-Ukraine war may increase the likelihood of the United States becoming a more significant exporter of oil.

EPD 2021 Q4 Presentation

Wall Street analysts are quite bullish with a 4.41 rating out of 5.

Seeking Alpha

The average price target of $28.93 per unit reflects modest upside of 12% from current levels. Again, price targets should be held back due to the inherent ceiling on earnings growth.

Seeking Alpha

Another factor is that EPD’s current dividend yield is higher, but not significantly higher than historical levels.

Seeking Alpha

While I see high potential for multiple expansion, it is unlikely for that expansion to be that significant considering that it will take time for sentiment to shift so positively for the energy sector.

Is EPD Stock A Buy, Sell, or Hold?

At current levels, EPD is trading at a 7.2% yield which has suddenly become fully covered by free cash flow. Every month that energy prices remain high, EPD’s tenants are improving their balance sheets. If the United States can become a more significant exporter of commodities, then those credit profiles improve even further. I previously expressed doubt that the stock can hit a 5.5% yield. I still find that unlikely. That said, my view of the downside has improved significantly in light of the higher commodity prices and outlook for United States commodities. I can see the stock trading up to a 6.3% to 6.5% yield, suggesting around 10% capital appreciation upside. Alongside 2% to 3% of annual growth, the stock can deliver around 10% annual returns before accounting for projected multiple expansion. If the company decides to lean more into unit repurchases, then the likelihood of hitting that 6.3% yield (or even lower) increases substantially, though I reiterate that I expect the company to prioritize external acquisitions as a close substitute to growth capital expenditures. Because my bull thesis hinges on the improving credit profiles as powered by high energy prices, the key risk to this thesis is a crash in energy prices. If that were to occur, then I wouldn’t necessarily expect a huge hit to EPD’s cash flows. The fact that the distribution is fully covered by free cash flow has greatly reduced the risk to the distribution, which was already one of the least risky in the sector to begin with. Instead, a worsening outlook would reduce the likelihood of multiple expansion and increase the risk profile while reducing the return profile. Because I do not expect commodity prices to plunge so low nor so fast, I rate the stock a buy.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

I am long all holdings of the Best of Breed portfolio.

Comments

[rickevantodd]

Thank you for your article and changing your position, as the facts changed. Normally not seen!

[RealRural]

An interesting point I had not thought of, regarding EPD's pipeline users taking advantage of high oil and gas prices to lower debt and risk, thereby benefitting EPD as well. Thanks.

Long since 2016, and sorry I didn't add more after the COVID crash when yield was 13%. My YOC is around 10% and EPD is a long-term hold for income and any capital appreciation is gravy for me. Well aware that fossil fuels face climate change headwinds despite the current jump in prices and as you note, appreciation will be modest as a result. But this is a well-run company that has garnered trust, which is more than can be said for other MLPs.

[reganbaha]

@RealRural I don’t understand your first paragraph. Do you mean that in a time of high prices, E&P guys will maximize volumes through pipelines?

[rickevantodd]

@reganbaha I think the commenter meant that with high oil prices the customers are getting stronger which, in turn, makes EPD stronger.

[asg01]

@rickevantodd
Exactly my take on the intent of that statement. And, I agree.

[jraskib]

Julian, thanks. Why to consider EPD? Isn't ET having much better upside, div wise, as well as a capital grows?

[John749]

Julian I just filed my tax forms today, long term CPA warned me again about
the danger of stocks this year, he thinks maybe I should take my winnings and
go to cash. I don’t, I trust him implicitly as a tax expert but all CPA’S must be
linear thinkers this period is going to kill many companies, hurt everyone as
Stagflation accelerates as he knows. The problem is cash is the most dangerous investment other than calling debt(Bonds, Loans, Lenders etc.) an asset or low or no profit companies. So what to do, I started preparing for Stagflation in 2020 one of my first choices was EPD as 2021 progressed I grew
it to by far my largest holding and sold wonderful stocks and ones I expected to suffer, by 2022 I had my Stagfolio built. It is counterintuitive to all rules and absolutely any Expert couldn’t do it. Why did I put so much of my wife’s income in the hands of EPD and a few similar hard assets is easy.
In 2021 I returned 9% on my Basis and will have returns over 10% in 2022 several of my holdings have already announced increases for the upcoming
distributions. Of course EPD will increase in January for the 24th year in a row.
This is the punch line my tax on many thousands of new dollars I received
in 2021 was ZERO and all my portfolio is TAXABLE.
I explained to my wife after our meeting the reason she should not fear the
future which is years of hurt even if her portfolio decreases just add more
units to her holdings, buy more income enjoy life. We are able to reinvest everything if we needed too but we take out a nice amount of cash to buy wants and help others. Why fight the market when EPD is a perfect
Stagflation choice. The following Stagflation parameters all fit EPD.
1. Sells must have products at great margins with not only enough cash flow to distribute to Partners but enough left over to buy or build more real world assets.
2. Very safe long term fixed debt at a low rate!
3. Deals in Billions and has very high revenue per employee (Many good Companies will suffer, too many employees needed at increasing cost)
4. Smart Management (Brain Power is Always in Short Supply)
In early 2021 as I shared my previous Stagflation experience here on SA
I had many people in effect assure me Inflation would not be a problem that Interest would never exceed 2.5% much less see double digits just couldn’t happen. I told them Prime reached 20% in 79/80 to break Stagflation.
It’s not too late with Select MLP’S to invest now get safe, the huge growth in
EPD’S Petrochemicals assets in 2021 added to the recent purchase of Navitas
for 3.25 Billion in cash giving them control of 20% of Natural Gas from the
Permian Basin. Just shows how truly smart their Board is.
Switch any Stocks of non safe Companies to EPD ASAP.
I am not the only one warning people now.
Best Luck
John

[Rick234]

Wish there was an option to own EPD without K-1s.

[RealRural]

@Rick234 Indeed, but you can own CEFs that hold MLPs with only modest drop in income and diversification benefits, that do not require filling out K-1 forms.

[reganbaha]

@Rick234 just buy in a foreign account and lever up to offset the 37% drop in dividends. Simples

[$4nothing]

@Rick234 $MLPA

[cptorrey]

Long EPD for many years now. Has management expressed a desire to grow the annual distribution by more than the current 2 1/2 % growth rate.
Thanks for the informative article.

[j2d2]

Long EPD. I think it’s position in 5 years will be a function of where interest rates are in 5 years. If inflation takes off and rates skyrocket, I’d expect their unit payout not to keep pace, even with their stability and even with growing revenue. The price will fall. It’s pretty much a bond surrogate. That said, it’s a steady payer and you have to put money somewhere.

[scottiebumich]

@j2d2 you really don't understand the business. If inflation stays high their fees peg to inflation so they will be higher while they inflate away their debt (which is fixed).

[me66]

@scottiebumich , that is how I understand things.

[RealRural]

@scottiebumich Are you saying they actually peg to inflation metrics? Or do they simply have a lease escalation or increase clause, like a REIT? I thought EPD's users signed contracts for throughput at a set price for a set period and then they negotiate for a new contract?

[OffSiteLocation]

The risk adjusted returns are indeed excellent, and for those who have significant income the tax benefits of the distributions really sweeten the deal.

[Julian Lin]

@OffSiteLocation thank you for sharing

[AZ BOY]

The major hope I have is for all pipelines to significantly reduce CapX and just bring home the bacon.. reduce debt.. increase the dividend… Until the Feds are more friendly with regulations, why do it… We all know it is total BS we will be clean fuel world in 5 years… Let’s make big money while foolish leaders run things in Washington….

[Julian Lin]

@AZ BOY At this point, I do not see EPD reducing debt, even if, as you said, it is one great use of capital. Multiple expansion will drive forward returns, and reducing leverage is one easy way to do that.

[RealRural]

@AZ BOY So you think the UN climate chief is blowing smoke when he says we are "sleepwalking to a climate catastrophy?"
news.un.org/...

Perhaps the "foolish" people are those who ignore the obvious., blinded by their ideology and narcissism? Let alone remarkable willingness to ignore the obvious.

What good is "making big money" going to do for the young people inheriting a world of climate driven chaos, dislocation and drought, and ever-increasing deadly storms? If you can't look beyond your own needs, it's a sorry and sad situation.

[Peter Frorer]

@RealRural Has it ever occurred to you that liberal-leaning politicians have promoted climate crises ideas ever since television news became mainstream (end of the world stories have been popular since the 1960's)? Politicians promote environmental problems to help themselves get elected, the concept is used to motivate their otherwise disengaged voter base. The media piles on with all sorts of frightening speculation since that helps drive viewership and advertising dollars. The notion that we face manageable pollution challenges is just far too boring and limp a topic to satisfy politicians and the media, surely you see that? Perhaps we will need to manage our CO2 levels in the years to come, but doing so will be accomplished by technological innovation, not by the half assed politicians that don't understand physics, chemistry, and atmospheric engineering. It's easy for people with no skin in the game to promote revolution and hydrocarbon abandonment, sounds like fun, right? GreenPeace has Germany so wrapped up in chaos, we are going to benefit from watching all the mistakes made by those with the best of intentions. California and Massachusetts are also going to waste hundreds of billions as their engineering-illiterate politicians try all sorts of foolishness. Hopefully, the rest of the world is watching and can adjust their power source investments more wisely along the way.

[listen25]

It was fairly apparent that EDP got too cheap during the 2020-21 time period. However, I am not in a position to fault Julian for his bad timing because I too have sold stocks at their lows instead of holding them for the upswing. Most recently I sold a third of my AMGN at a little over 200, and have been grinding my teeth every time I see a quote for it now at over 240. I am grateful to have purchased - and plan to hold - a lot of EDP during the lows, which does help me not think about AMGN as much.

[Julian Lin]

@listen25 Thank you for sharing

[arbtrdr]

Why do you think EPD will focus on external acquisitions? While I agree that EPD management would purchase assets at an attractive price that fit the EPD footprint - Navitas was a steal at about 6X IMO; they have mostly done organic asset builds for over 15 years. Purchases like Oiltanking were the exception to new pipes, dockage and chemicals.
I do agree EPD would purchase a chemical business that both "fits" and is reasonably priced. The obligation of the BOD is to maximize the ROI to benefit the unitholders.
The question for midstream MLPs seems to be how to best use the cash. What use has the highest ROI? Obviously Navitas ROI is well above either buybacks, debt repayment or distribution increases and has no time lag like the PDH2 plant.
Guess my question is what does the balance sheet, distribution and debt levels look like in 5 years. Am guessing some billions allocated to each, reduced by opportunities to acquire assets in the 6X area

[Julian Lin]

@arbtrdr "they have mostly done organic asset builds for over 15 years."

Correct, but public policy may prevent them from continuing to build.

[reganbaha]

@Julian Lin but this policy creates an economic moat around them vs potential competitors.

[Julian Lin]

@reganbaha That is arguable, yes.

[labman106]

Own EPD and MMP. War tensions are showing the world that energy is a must have given countries are too slow subsidizing wind and solar to actually make a difference. Wonder how many Greens would cut down trees to stay warm.? Would be great if some news network would publish a list of products that
are made from oil. How many components in a typical cell phone are made from oil?

[Algorithmic]

@labman106 the better question is “how much oil is in ALL the cellphones in circulation?”

Oil is far more useful as a manufacturing material than something you burn in gasoline.

My guess is that oil can be $500 a barrel and the cost of a cellphone would barely budge.

[houtex]

@Algorithmic
Bingo. I know people love to point out that oil and gas have non combustive purposes, but they need to understand what they are implicitly proposing. If tomorrow every environmentalist and industry person agreed that oil and gas are too important to plastics and other non combustive uses, so we are going to continue to produce enough for that but we are going to 100% eliminate the combustive uses of oil and gas, every single energy company is going bankrupt. Literally every one. All your investments are zero.

You are correct. The observation that oil and gas are used in cellphones is snark and nothing more. If that’s your investment case, give up and go home. It’s done.

Of course the good news is that there’s no way we are getting away from oil and gas as energy sources, so focus on that.

[RealRural]

@Algorithmic Good points.

The conundrum, of course, is that petroleum is essential to the plastics that make modern life what it is, but at the same time plastic pollution and our massive wasteful throwaway societies - more than 100 MILLION cell phones are discarded each year, including all their hazardous materials - are killing animals, destroying the ocean ecosystem, and driving plastics related environmental illnesses in humans. All you need to do to despair is look at the photos of third-world rivers absolutely clogged with plastic trash.

Until we deal with this, impacts will measurably affect life around the planet.

[KamilAgrawala]

I have a large position in EPD, was buying below 15 during COVID and even some at below 11. I rate EPD a moderate buy now, it is not a steal anymore. Dividend growth has stagnated and smaller midstream players such as HESM and CEQP can be considered better adds. I am still long EPD on my cost basis, and love ENB too.

[Julian Lin]

@KamilAgrawala Well done!

[01ruxbunny03]

I own EPD and am here for the dividend.Share price growth is barely even an afterthought for me.And for me,raise the dividend.Share buybacks are not something that I desire.

[Julian Lin]

@01ruxbunny03 A lot of investors have the same strategy

[dldr]

I'm long EPD, find the author's arguments reasonable and his articles generally well-written. And while I respect the author's willingness to point out that EPD outperformed the S&P since he sold it, it gives me little confidence in the timeliness of the author's ratings. Please check my math. 95 covered stocks with 18 Strong Buys. 3 of the 18 are up 20% or more (33%, 24%, and 21%), while 9 of 18 are down 20% or more since the author's Strong Buy rating. PINS down 60%, UPST down 45%, TWLO down 21%, AI down 52%, ROKU down 29%, FB down 35%, SKLZ down 75%, ETSY down 34%, and CURLF down 52%. No doubt we all pick the occasional loser, but I must respectfully ask the author how is it that you are "ranked in the top 1% for financial performance on Tipranks"? I am flummoxed.

[Julian Lin]

@dldr The recent performance has been poor, but the long term performance is arguably not too shabby. My tip ranks link is here:

www.tipranks.com/...

Check bacon in 6 months, and it should be even better.

[Ted Waller]

@Julian Lin interesting bacon recipe.

[Rellif]

@Julian Lin You made my list with EPD.

docs.google.com/...

This file auto updates. However during market hours it may be slow to update as Googlefinance can't keep up sometimes. I will be adding more to the list as they become "recommended". If you have some to add, let me know.

[Peter Frorer]

Julian, imagine what happens to your thesis if EPD not only gains a multiple expansion as you described but also is able to find growth opportunities. With the changes taking place in Europe affecting all nations that must consider national security, we are possibly or likely going to see many countries focus more closely on the source of their energy supplies. This bodes well for all domestic pipelines in the USA but also suggests US exports for oil and LNG have a new, much higher growth potential. EPD ought to continue to lead the nation as an energy export enabler. Furthermore, you failed to mention any suggestion that EPD may embark upon a "renewable" growth spurt via relationships and JV ideas in hydrogen or CCUS ventures. The home run potential here is that EPD continues on making massive returns with the assets already in place but also finds tens of billions to invest in the "cleaner" energy sources that so many people seem to think we need. I am not yet sure that hydrogen and CCUS are going to offer hundred billion dollar investment opportunities, but it is clear that if anyone is going to find ways to grow significantly in these two areas of "renewable" investing, that EPD will be there in size!!!! If that happens, then EPD will be a massive long-term wealth creator (frankly, it already is).

[reganbaha]

@Peter Frorer will growth in hydrogen and CCUS etc actually be profitable in the medium term or just satisfying ESG headlines in a me-too fashion?

Unless something more unique, maybe CO2 -> SAF if the technologies work, then maybe be cautious.

[elliot_mllr]

@reganbaha :
EPD management was very clear that while they will review many green type programs they will only invest in those that show an adequate return on invested capital.
Elliot Miller

[Ed Cwedward]

@Peter Frorer I agree that the world will look toward the USA for its petroleum needs. The green new deal will continue to fall apart.

[georgios]

Apart from the 2-3% growth that you mention, which I think is low, there is also the price inflation they will be enjoying from the FERC. Add that to the higher price of commodities and health of their customers and you are looking at a totally different picture.

[Howard CostaRica]

I think the first time I saw Rida mention this stock was on 12/22/21. Perhaps the 1,000 shares I purchased that day was from you?

I am pleased that I got in at $20.81 and realizing a 24.27% increase in the value of my position and a yield of 8.47%. Thanks again Rida!

Good analysis. Thanks.

[dl4]

@Howard CostaRica me too

[Income4ever aka Cyclenut]

"With EPD yielding around 7.2%, the stock could prove to be a great addition to income-seeking portfolios."
EPD has been a proven addition to income portfolio for many years now, one of the best .....depending on entry point of course....

[Arimnestos]

It seems to me that the Russian invasion of Ukraine greatly increases the prospects for a positive FID on the offshore project (SPOT) soon. If so, capital expenditures will increase significantly over the next few years. Completion of that large project and PDH2, which is even bigger IIRC, should propel cash flows more than the author suggests. In the current energy environment, EPD's future looks extremely bright. Long EPD, MMP, WMB