Companies evolve and change over time, particularly those that have long operating histories. Enterprise Products Partners (EPD 0.38%) recently went through a subtle but important transition. Although the master limited partnership (MLP) is still a North American midstream giant, it isn’t the same MLP it was just five years ago.
Midstream was all about growth until it wasn’t
Enterprise Products Partners owns energy infrastructure. These are vital assets, like pipelines and storage, that help move oil, natural gas, and the products into which they get turned around the world. For the most part, the partnership charges fees for the use of its assets, which creates fairly reliable cash flows over time. Contracts generally include annual price increases, but they tend to be modest. This is important.
The way that midstream companies tend to grow is through the addition of new assets. That can come via acquisitions of existing infrastructure (or entire companies) or from ground-up construction. For many years, there were a lot of opportunities for midstream companies to grow, and investors were happily willing to help finance that via the equity and debt markets. During this period of time, Enterprise, like its peers, didn’t need to worry so much about finding cash for expansion. Times have changed.
Today, most of the best investment opportunities for new projects have been exploited. There has also been an increasing pushback against major energy projects, adding costs and delays and even leading to outright project cancellations. Investors are no longer quite as positive about funding capital investments in the midstream sector despite the still vital nature of the services it provides to the global economy.
Enterprise changes with the times
That shift in the midstream sector is what led Enterprise to adjust its approach. Historically, it happily spent above its internal cash-generating capacity because the market allowed it and generally rewarded the MLP for doing so. But when that was no longer the case, management made the decision to slow down distribution growth so it could strengthen its financial position. The end goal was for Enterprise to replace its use of issuing equity with internal cash flow to fund more of its own capital investment projects.
A key inflection point took place in 2021. In the years leading up to 2021 discretionary cash flow per unit was negative. In 2021, it turned positive. The numbers are fairly large, as well. For example, in 2017 discretionary cash flow per unit was negative $0.99. It slowly improved to negative $0.22 per unit in 2020. In 2021, it was positive $0.43 per unit.
Distribution growth, meanwhile, has changed as well. As the chart above shows, the MLP shifted from increasing the distribution quarter to just once a year in 2020. The distribution was increased just modestly in 2020 and 2021. Once discretionary cash flow turned positive, distribution growth sped up in 2022.
To be fair, capital spending has fallen. It peaked at $4.2 billion in 2019 and hit a nadir of $1.6 billion in 2022. In 2023, capital spending is projected to be around $2.3 billion, which is still materially below 2019 levels. Given the industry backdrop, lower spending is likely to be the norm. Leverage has also been reduced, with debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) at roughly 3.2 times, near their lowest levels over the past decade.
Stronger and better positioned
All in, Enterprise adjusted in a logical way to the new environment it was facing. It is in an extremely strong position to support its distribution, with distributable cash flow covering the distribution by 1.8 times in the second quarter of 2023. The MLP should be able to continue increasing the distribution in the future, as well, adding to the 25 years of annual hikes it has achieved thus far, as new, self-funded projects come online. Cash needs will wax and wane along with opportunities, but the subtle changes made here mean that Enterprise isn’t the same MLP it was before.
If you are an income-focused investor, Enterprise’s ultra-high 7.5% distribution yield may be worth a closer look. That’s especially true if the last time you considered this midstream giant was a few years ago.