2 Sky-High Safe Yields: Western Midstream And Enterprise Products Partners

Summary

• EPD just reported Q1 results and we break down how it impacts our investment thesis.
• WES has not yet reported, but is a compelling buy at the moment.
• We look at the valuations for both and discuss which one we find more attractive at the moment.
• Looking for a portfolio of ideas like this one? Members of High Yield Investor get exclusive access to our model portfolio. Learn More »

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High yield and low risk are two adjectives that many investors believe do not belong in the same sentence. However, thanks to a unique combination of macro events and strong politically-charged viewpoints impacting Wall Street investment trends, we are today looking at quite a long list of common equities that offer very high yields without that much risk.

Today we will look at two of these securities - Enterprise Products Partners (NYSE:EPD) and Western Midstream Partners (NYSE:WES) - that both boast solid investment grade balance sheets, stable cash flowing business models, and sky-high and very safe distribution yields.

Note: Both EPD and WES issue a K-1 tax form, so keep this in mind before adding them to your portfolio.

#1. EPD: The Retiree's Ultimate SWAN Investment

EPD boasts arguably the finest combination of midstream infrastructure assets, management, and balance sheet strength in the industry today. Its asset portfolio is well-diversified, high quality, and battle tested, earning it a Wide Moat rating from Morningstar. Meanwhile, insiders own about a third of the company's common equity units and returns on invested capital have been consistently in the double-digits regardless of the macro environment. Last, but not least, its BBB+ credit rating is tied for tops in the sector and has enabled management to consistently grow the distribution through boom and bust periods for the industry.

After reporting Q1 results, EPD's assets, management, and balance sheet ratings remain stellar in our view. Oil pipeline transportation volumes increased by 16% year-over-year, crude volumes in its marine terminals soared 39%, and natural gas pipeline volumes jumped by 20%. Meanwhile, its $4.6 billion in capital projects underway in combination with the synergies and growth opportunities offered through the Navitas Midstream indicate that EPD should have a lengthy growth runway ahead of it. In fact, management doubled down on this during the earnings call when asked by analysts if growth CapEx remained the top priority for excess cash flow moving forward as opposed to unit repurchases.

That said, management also remains focused on returning capital to unitholders through the distribution. Distribution coverage stood at a whopping 1.8x in Q1, making it safer than ever and giving them plenty of runway to continue growing it in the quarters and years to come.

Last, but not least, the balance sheet remained in stellar shape with leverage at 3.4x and trending downwards as EBITDA is expected to continue growing. Liquidity was also impressive at $3.9 billion in combined available credit capacity and unrestricted cash.

#2. WES: Ultimate Combination Of Yield, Buybacks & Growth

WES is a midstream oil company that gathers, processes, and transports natural gas and natural gas liquids (i.e., NGLs). The company operates assets located in Texas, New Mexico, the Rocky Mountains, and North-central Pennsylvania. As a midstream company, WES sits between natural gas production (upstream) and delivering the natural gas to end-users (downstream).

As a midstream business, the company generates substantial free cash flow from the established assets that required years of capital investments. The business has barriers to entry due to the high level of capital investments and regulatory approvals that were necessary for the business to grow.

At the beginning of January 2020, Occidental Petroleum (OXY) spun off WES as its own company. This move was made so that Oxy Petroleum could shed some debt onto the newly spun WES business and so Western Midstream could focus on pursuing the opportunities unique to its midstream assets.

During fiscal year 2021, the company generated a whopping $1.45 billion in FCF after ~$315 million in capital expenditures. It's worth noting that a lot of the money invested in capital expenditures is in growth investments, which gives management the opportunity to invest in areas that will grow the business instead of solely maintaining assets.

Additionally, the company has stepped up their distribution policy, committing to a distribution payout of $2/unit for the year, yielding investors an 8% distribution at $25/unit. When you count all the cash flows the business generates, the company can generate a double-digit unitholder yield. We believe that this business will continue to create strong free cash flows for unitholders supporting a hefty yield for years to come.

WES’s management has proven to be effective capital allocators, and their plans for the future seem to reflect the same capital stewardship.

In the most recent quarterly report, the company shared how they had returned ~18% of the business's enterprise value to unitholders since January 2020, when the company was spun out of Oxy Petroleum. This is significant because the company has essentially created ~$2.8B in free cash flow since the spin-off, and we can see that the money was used for good purposes.

For 2022, management is guiding for ~$1.25B in FCF for 2022. With ~400M units outstanding, that means the business will pay out $800M in distributions. This distribution is an increase from last year, and you can see it's well covered by cash flows:

Based on current market conditions and estimates, we plan to declare a quarterly base distribution of $0.50 per unit, effective with our first quarter 2022 distribution, which is an increase of approximately 53% compared to the distribution declared in the fourth quarter of 2021. The new base distribution will result in an annualized cash distribution of $2 per unit.

- Q4'21 Earnings Transcript

After paying the distribution, the business will have ~$425M of FCF to use for debt repayment or opportunistic unit repurchases.

Another quality we like about WES is that the majority of the company's cash flows come from fee-based contracts. Since the contracts are fee-based, the company still makes money even if lower volumes go through, and they have minimum-volume commitments in place to make sure that even if commodity prices take a dive, there will still be a certain level of throughput (volume) that WES will make money from:

We believe a substantial majority of our cash flows are protected from direct exposure to commodity-price volatility, as 93% of our wellhead natural-gas volume (excluding equity investments) and 100% of our crude-oil and produced-water throughput (excluding equity investments) were serviced under fee-based contracts for the year ended December 31, 2021. In addition, we mitigate volumetric risk through minimum-volume commitments and cost-of-service contract structures. For the year ended December 31, 2021, 81% of our natural-gas throughput, 96% of our crude-oil and NGLs throughput, and 100% of our produced-water throughput were supported by either minimum-volume commitments with associated deficiency payments or cost-of-service commitments.

- WES 2021 10-K

At today's prices, WES offers double-digit unitholder free cash flow yields for investors. Investors would see returns from the distribution, unit buybacks, capital investments, and debt repayment that the massive cash flow would go towards.

WES is estimated to make $3.75/unit in distributable cash flows in 2022, meaning the business offers a 15% DCF yield at a $25 unit price. From 2022 to 2026, the cash flows per unit are estimated to grow at a strong 13% CAGR - which means that every year you'd earn a higher yield on your initial investment:

We believe that this attractive valuation gives us the opportunity to buy a cash-flow generating business with a double-digit unitholder yield.

Investor Takeaway

Both EPD and WES boast solid cash-flowing business models and attractive yields. While EPD is second to none in terms of balance sheet strength and management quality and its asset portfolio is considerably stronger than WES', WES has pretty good ratings in each of those areas as well.

Meanwhile, its valuation looks very compelling, while EPD's looks attractive, but not nearly as lucrative as WES'.

WES's EV/EBITDA ratio is 8.25x compared to its 5-year average of 10.15x, implying significant upside potential from multiple expansion. Meanwhile, its forward distribution yield is 8.27%. In contrast, EPD's EV/EBITDA is a full turn higher at 9.30x (though it warrants a higher multiple and has similar upside potential relative to its 5-year average of 11.11x) while its distribution yield is 7.18% on a forward basis, 109 basis points lower than WES'.

However, where WES really distinguishes itself in the valuation department is its lower price to DCF multiple and stronger DCF per unit growth potential for the foreseeable future. EPD has a P/DCF ratio of 8.2x whereas WES has a P/DCF ratio of just 6.25x. On top of that, EPD is expected to grow its DCF per unit at a 4.9% CAGR over the next half decade whereas WES is expected to grow its DCF per unit at a 7.6% CAGR over that same time span. This superior growth rate is largely due to the fact that WES is retaining a significantly greater portion of its DCF than EPD is and is able to repurchase units at very low multiples.

While we believe both MLPs deserve a spot in an income investor's portfolio, WES is a stronger buy at the moment in our opinion given its significantly cheaper valuation and commitment to returning a lot of cash flow to investors via distributions and buybacks.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of EPD, WES either through stock ownership, options, or other derivatives. 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.