Co-produced with Hidden Opportunities
Whenever someone speaks on fossil fuels or oil, undoubtedly someone pipes up with how they are a thing of the past! The future is renewable energy and Electric Vehicles. Yet, we often forget something: hydrocarbons are a vital part of our daily life. They are essential feedstock for a wide range of consumer goods.
Let us discuss Wall Street’s favorite topics:
Electric Vehicles: EVs are among the most discussed transformations today. Polymers are instrumental in the EV revolution. They are lightweight, inexpensive, easy to shape, durable, and flame retardant. Today, plastics make up to 50% of a vehicle’s volume but only 10% of its weight, an essential factor for EVs since the battery is one of the heaviest components of the car.
Renewable energy is a significant socio-political issue today. The current administration supports the transition to clean energy, and S&P Global Market Intelligence projects a record 2022 for wind and solar energy deployments. We need more wind turbines, solar panels, battery insulators, coatings, insulation, and other related materials.
Ironically, more EVs and renewable energy mean greater demand for plastics and polymers made from petrochemicals. Overall, the outlook for petrochemicals and their derivatives is vital, if not accelerated by modern transformations. Today, we make a bullish case for Enterprise Products Partners (EPD), one of the largest midstream pipeline companies in North America and a leader in the transportation and storage of these vital commodities – NGLs, refined products, natural gas, and crude oil.
Note: EPD is a Master Limited Partnership that issues a Schedule K-1. EPD’s earnings report is scheduled for the morning of February 1st.
Vital Assets In A Booming Industry
EPD owns and operates over 50,000 miles of pipelines, ~260 MMBbls of liquid storage and 14 Bcf of natural gas storage capacity, 19 natural gas processing facilities, 25 fractionators, 11 condensate distillation facilities, and 19 deepwater docks. In short, the partnership owns vital assets that are extremely difficult to replace, making it a significant moat that can be monetized for decades.
EPD’s revenue mix shows Petrochemicals and NGLs to constitute ~62% of the revenue mix, making it more of an opportunity in petrochemical bi-products like plastics than an energy midstream company, hence the name Enterprise Products Partners.
EPD operates the world’s largest propylene and ethylene systems and is the world’s largest exporter of Liquified Petroleum Gas (‘LPG’), a cleaner & high energy density, and easily transportable fuel for residential purposes.
EPD’s liquids pipeline throughput has strongly recovered to near pre-pandemic levels at 6.3 million barrels a day. The partnership’s natural gas pipeline and transportation volume for Q3 exceeded pre-pandemic levels at a record 14.6 Bcf/day. EPD’s distribution today is 4.4% above early 2020 levels, and despite the robust performance, EPD trades 17% below pre-pandemic levels.
EPD ended the Q3 with over $2.2 billion cash on their balance sheet and over $6.1 billion in accounts receivable. Let us now look at a recent acquisition made by the firm.
All-Cash Navitas Acquisition
EPD recently announced the acquisition of Navitas, a West Texas-based midstream operator with natural gas assets. EPD is spending $3.25 billion to acquire Navitas, and the transaction is being made using cash on hand.
The acquisition brings the following to EPD’s asset base:
~1,750 miles of pipeline assets.
Over 1 Bcf/d of processing capacity.
~10,000 drilling locations on dedicated acreage
Long-term contracts with over 40 E&P customers
Importantly, Navitas has no exposure to federal lands, a dead asset under the current administration’s policies. The Navitas acquisition provides EPD with an attractive position in the Midland Basin, and the transaction is expected to be immediately accretive to the partnership’s distributable cash flow (‘DCF’). Management is guiding $0.18 to $0.22 per unit in DCF increase in 2023.
This transaction increases the firm’s moat incrementally, and investors will reap the rewards through growing distributions. Speaking of growing distributions, let us review another exciting announcement from the firm.
24 Years of Growing Distributions
That is quite an impressive feat that not many companies can boast about. EPD recently increased its distribution by 3.33% to $0.465/share. This calculates to a 7.6% annualized yield. The partnership is just one more distribution increase away from achieving the coveted Dividend Aristocrat status, which will put it on the radar for even more dividend growth investors.
Most Dividend Aristocrats have yields far below 5%. The ProShares S&P 500 Dividend Aristocrats ETF (NOBL) yields a paltry 2%. This is your opportunity to lock in a very generous 7.6% yield from an “almost aristocrat.”
It isn’t enough for a company to provide a high yield. The distribution must be consistently earned and well-covered. EPD’s YTD DCF is almost $5 billion, which has provided coverage of 1.7x and $2 billion in retained cash year-to-date. This means the company is earning nearly 12.8% DCF return on your investment, out of which they pay 7.6%. The company has been using the retained cash for debt paydown, capital expenses, and the acquisition we just discussed.
Looking at the chart below, 2021 was the best year for EPD shareholders since 2006! TTM distribution payout as a percentage of the partnership’s Cash Flow From Operations (‘CFFO’) was the lowest ever at ~50%.
$2 Billion Share Repurchase Plan
The partnership has a $2 billion share buyback plan in place, of which they have utilized $387 million to purchase common units. During Q3, EPD purchased 3.4 million common units (for $75 million). A less appreciated benefit of buybacks is that the shareholders have access to a larger share of the DCF, indicating continued prospects for growing distributions.
Aggressive repurchases strongly indicate that business is thriving and the company has a sizable amount of excess cash. And that is after paying the generous yield! This is the monetization power of tangible assets. They will print money for decades to come.
High Insider Ownership and Employee Purchases
You know that the company presents a compelling opportunity when insiders load up on the stock. EPD has a phenomenal ~40% insider ownership (including employee unit purchases). Insiders have been taking advantage of the depressed stock prices and loading up through 2020 and 2021.
During Q3, EPD’s distribution reinvestment plan and employee unit purchase plan purchased a combined 1.6 million EPD common units ($36 million) in the open market.
Insider ownership and continued purchases instill confidence in shareholders. It ensures that management’s interests are aligned with those of the shareholders in long-term value creation and growing distributions.
EPD presents compelling value, Bill Gross is buying with both hands!
Insiders are not the only ones buying EPD. Legendary investor Bill Gross, also known as the (former) Bond King, has shown interest in natural gas pipelines. He revealed EPD as one of his top picks in the sector.
The billionaire founder of income-oriented investment management firm PIMCO has strongly recommended defensive stocks with attractive yields in response to the diverging dynamic between fixed-income yields and the raging inflation.
The energy sector is the cheapest today, and EPD is the cheapest within the midstream peer group despite having the highest yield and solid track record.
Applying 13-15x multiple (a reasonable multiple for a quality midstream company) to EPD’s conservatively projected $8 billion 2022 EBITDA, we calculate a price target between $28-32, indicating 15-30% upside from current levels!
Healthy Balance Sheet
EPD has taken advantage of the low interest rates to refinance its debt. The partnership recently issued $1 billion of senior notes at a fixed rate coupon of 3.3% to support the repayment of $750 million, 3.5% senior notes, and the $650 million of 4.05% senior notes maturing in February 2022.
Overall, EPD has extended its debt maturities by 30 years while reducing the debt coupon by almost 0.5%! Today, EPD’s average cost of debt is 4.4% and maintains a leverage ratio of 3.2x. This is much lower than midstream peers like ONEOK (OKE), Enbridge (ENB), Williams Companies (WMB), and Kinder Morgan (KMI).
EPD’s investment-grade balance sheet is an asset. And the low average cost of debt and extended debt maturities provide a lot of flexibility to utilize its cash flow to grow its asset base.
Think hydrocarbons are only used in energy and transportation? Think again. Even if you are seated on your couch, watching TV, you are interacting with one or more of its derivatives.
NGLs, refined products, and natural gas are critical in our lives, and their demand will be accelerated by net-zero goals and the increased adoption of EVs and renewable energy. In fact, the European Union has admitted that natural gas will be a big part of global decarbonization goals.
With 24 years of consistent dividend raises, EPD is almost a dividend aristocrat, yielding several times more than the average aristocrat. EPD checks every criterion that an income-seeking value investor seeks.
Yield as high as 7.6% with high 1.7x coverage
High insider ownership of ~40%
Sizable share repurchases ($2 billion buyback plan)
An investment-grade balance sheet with a low 4.4% cost of debt
Billionaire investor Bill Gross, known for his successful track record of income investing, is loading up on EPD, and so should you. This partnership is an excellent addition to an inflation-beating income portfolio.
I like my income to come from the most reliable and relatable sources. Your phone – hydrocarbons. Your car? Hydrocarbons. So why not your income stream?
Buy income that’s clearly tied to in-demand products or essentials for our modern society. You’ll enjoy it for decades to come.
Note: EPD is a Master Limited Partnership that issues a Schedule K-1