Enterprise Products Partners (EPD 1.79%) units have recovered from their post-COVID-19 pandemic lows. But they still haven’t regained the highs achieved before the 2016 energy downturn. While the midstream industry is different today than it was before 2016, Enterprise is proving it knows how to handle itself no matter what the energy sector throws its way. Here’s why this North American midstream giant is worth buying while it is below $35.
What does Enterprise Products Partners do?
Enterprise is a master limited partnership (MLP), which means it is a pass-through entity designed to provide investors with a large income stream. There are pros and cons to being an MLP. For example, some of the income investors receive will be protected from current-year taxation because it gets classified as a return of capital. That’s good news, of course, but it means that taxes will be higher when the stock is sold because return of capital lowers the cost basis of the investment. And then there’s the K-1 form to deal with come tax time. All in, however, more active income investors will probably find Enterprise’s 6.8% yield enticing.
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That yield is backed by one of the largest midstream businesses in North America. Enterprise owns a vast collection of pipelines, storage, transportation, and processing assets. The North American energy sector probably couldn’t operate without Enterprise. That said, Enterprise charges fees for the use of its assets, so the volume of products it moves is more important than the price of the products it moves. As such, cash flows tend to be pretty strong in both good energy markets and bad ones.
The big switch that happened in 2016 was that the midstream business effectively shifted from rapid growth to slow growth. Prior to 2016, there was a rapid pace of ground-up construction, which is the main driver of growth in the midstream sector. But most of the good opportunities for growth have been exploited at this point. Now, the industry is focused on incremental growth projects and consolidation, as smaller businesses get swallowed up by larger ones.
Enterprise shifted gears and is ready for the new market dynamic
Enterprise saw the writing on the wall in 2016 and changed its business model. Prior to that point, it was able to sell units easily and use that cash to support its capital spending needs. It was comfortable with distributable cash flow covering its distribution by roughly 1.2x. Today, the coverage is up to 1.7x, which gives Enterprise the financial leeway to fund more of its capital investments internally. It also means that there is more leeway for adversity before a distribution cut would be in the cards.
This business shift, however, didn’t stop Enterprise from growing where it counts. Notably, the distribution has now been increased annually for 26 consecutive years. While distribution growth did slow down for a few years as the MLP transitioned its business model, the last couple of years have seen mid-single-digit distribution growth. That’s above the historical rate of inflation growth and means the buying power of the distribution is increasing over time.
Backing that distribution growth are three key pillars. The first is contractual fee increases. The second is Enterprise’s $7.6 billion capital investment plan. And the third is the MLP’s ability to act as an industry consolidator, given its industry position, size, and investment-grade-rated balance sheet. The first two items here suggest slow and steady distribution growth. The last one can’t be predicted, but Enterprise has a long and successful history of growing via acquisition. There’s no reason to believe it won’t continue to grow in this way.
Enterprise is better today than it was in 2016
Enterprise’s trailing-12-month revenue is higher today than it was in 2016. Its business is stronger financially, as well. The MLP’s unit price is steadily crawling back toward its 2016 highs thanks to ongoing distribution growth. Since the distribution looks likely to keep growing in the future as it has in the past, this industry-leading midstream player looks like an attractive investment today, while it trades below $35. While the hefty 6.8% yield will likely make up the lion’s share of total return over time, that probably won’t be much of an issue for income-focused investors.