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[Bong Hwan Ahn]

2 Top Reasons To Buy 7.4% Yielding Enterprise Products Partners

Feb. 13, 2023 6:42 AM ETEnterprise Products Partners L.P. (EPD)13 Comments12 Likes

Summary

• Enterprise Products Partners reported strong FCF for FY 2022 and recently raised its dividend by 3.2%.
• EPD has less exposure to market prices than producers, which is why I prefer midstream companies in general right now.
• EPD has a very unitholder-friendly management and returns a ton of its free cash flow to investors.

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Enterprise Products Partners (NYSE:EPD) is a fast-growing and well-run midstream firm that owns a large pipeline network and associated energy infrastructure. The company generates the majority of its earnings from its long term transportation contracts with producer clients which generates enormous cash flow predictability for unitholders. Enterprise Products Partners is also aggressively investing in capacity growth which indicates that the firm's cash flow will grow going forward. Last but not least, Enterprise Products Partners last month raised its dividend again by 3.2% and management returned 71% of its free cash flow to unitholders in FY 2022!

Two top reasons to buy Enterprise Products Partners

I have sold all my holdings in producers like Exxon Mobil (XOM) and BP (BP) after a surge in petroleum prices has led to record profits for these companies. Because I believe there is considerable potential for petroleum and natural gas prices to correct to the down-side in FY 2023 due to slowing economic growth, midstream firms offer better value, in my opinion, since they have more resilient cash flow and their dividends have more potential to grow. Investors that are looking for investments in the energy sector and share my concerns about the possibility of declining profitability for producers, may want to consider EPD for two specific reasons.

1. EPD is a large, diversified midstream firm offering cash flow predictability

Enterprise Products Partners is a fully integrated midstream company with extensive pipeline networks regarding NGL, natural gas, crude oil, refined products and chemicals. The midstream firm also owns other energy infrastructure assets like natural gas processing, distillation and storage facilities. Simply speaking, EPD is a crucial element in the energy value chain that makes sure that energy products move quickly and efficiently from producers to end consumers. The pipeline network alone includes more than 50 thousand miles of pipelines and with a market cap of $56B, EPD is one of the largest, integrated midstream firms in the country.

Source: EPD

Midstream firms like EPD make their money differently than producers like Exxon Mobil. Midstream companies sign long term delivery contracts with their customers which make sure that energy products can flow through pipelines for a pre-determined fee. This fee arrangement dramatically limits Enterprise Products Partners' exposure to volatile market prices for crude oil or natural gas… which creates cash flow stability.

In FY 2022, Enterprise Products Partners had a total fee share of 74% compared to 82% in FY 2021. Although the fee share dropped year over year, the overwhelming majority of the company's gross operating margin remains linked to fixed fees which greatly reduces EPD's exposure to market prices. For this reason alone, I would expect EPD's unit price to be less volatile than the stock prices of producers, for example.

Source: EPD

2. Free cash flow strength, growth investments and unitholder orientation

The fee-based nature of doing pipeline business translates to exceptional free cash flow that is used for capacity-enhancing investments and for distributions to unitholders. Enterprise Products Partners generated $2.9B in free cash flow in FY 2022, showing a decline of 53% year over year. However, the decline only occurred due to aggressive investments in new growth opportunities such as the acquisition of midstream assets earlier in FY 2022. EPD's operating cash flow was fairly stable at $8.0B compared to $8.5B in FY 2021.

Source: EPD

Enterprise Products Partners is investing heavily in its natural gas business which is the company's largest business segment with an approximate 55% gross operating margin share. One of these growth investments relates to the acquisition of Navitas Midstream Partners in February 2022 which cost Enterprise Products Partners $3.25B. The acquisition was completed in order to improve EPD's natural gas positioning in the Midland Basin of the Permian. If it wasn't for this acquisition, Enterprise Products Partners' free cash flow in FY 2022 would have been around $6.0B.

Currently, EPD has about $5.8B in growth investment under construction, the majority of which will start to make positive cash flow contributions after FY 2023.

Source: EPD

What I believe makes EPD especially interesting to dividend investors is that the company is very friendly towards unitholders. The midstream firm returned more than 70% of its free cash flow to unitholders in FY 2022, most of which ($4.1B) were dividends. EPD also repurchased 10.2M units for $250M in FY 2022. Going forward, dividend returns will likely continue to make up the majority of EPD's capital returns.

Source: EPD

In January, Enterprise Products Partners again raised its quarterly distribution, this time by 3.2% to $0.49 per-unit which means EPD now yields 7.4%. The firm's unitholder-friendly management has raised its payout consistently for 24 years and the large backlog of growth investments that are expected to be completed in FY 2023 and FY 2024 can be expected to back EPD's dividend growth going forward.

Enterprise Products Partners vs. rivals

I currently prefer EPD in the midstream sector because the company just delivered yet another dividend increase. Additionally, Enterprise Products Partners has a very attractive valuation based off of EBITDA which is often used to value midstream firms. EBITDA is a useful measure to value midstream companies because this figure does not include non-cash charges like depreciation and amortization and midstream firms often report billions of dollars of such charges each year.

I believe EPD could achieve $9.6B in EBITDA next year. The consensus is slightly lower and sits at $9.5B. Using the lower estimate here to be on the safe side, EPD has an EV/EBITDA ratio of approximately 9.3 X… which makes Enterprise Products Partners' units the cheapest when compared against Kinder Morgan (KMI) and Enbridge (ENB). While I also own Kinder Morgan, I like EPD the best due to its growth investments and dividend growth.

Data by YChartsRisks with Enterprise Products Partners

Enterprise Products Partners is a well-run midstream firm, but there are risks to the company's cash flow. A down-turn in the energy industry would likely also affect midstream companies through lower volumes, although likely to a lesser degree than the producer segment which is more exposed to market prices. What would change my mind about Enterprise Products Partners is if the company saw a steep decline in its free cash flow or if it were to stop growing its dividend.

Final thoughts

There are a couple of reasons why I like Enterprise Products Partners at a current price of $26. The first is that the midstream firm relies on long term transportation contracts that set out pre-determined fees and don't depend on the general direction of market prices. Since my expectation is that petroleum prices will continue to fall off in FY 2023 due to rising economic risks, midstream firms like EPD may be better bets on cash flow predictability and dividend growth than producers, in my opinion.

The second is that EPD continues to invest heavily in capacity growth which sets the stage for long term cash flow growth. The midstream firm paid $4.1B in dividends in FY 2022 and EPD just raised its dividend again by 3.2%. For those reasons, I believe EPD is a rock solid dividend investment for investors that value dividend growth and continuity!