Market Overview

This High-Quality MLP Could Be Attractive For Income Investors

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Income investors should consider Master Limited Partnerships, also known as MLPs, for their high yields. With the stock market at record highs, the average dividend yield in the S&P 500 Index is currently below 2%. And since interest rates remain low, many fixed-income securities are unappealing for income investors.

This is why MLPs could be a better option—income investors can generate fairly high yields, along with increasing payouts from the strongest MLPs.

Of course, investors must do their due diligence, as is the case with any potential investment. For investors interested in high-yield MLPs with growth potential, Enterprise Products Partners (EPD) could be an attractive option for income investors.

Business Overview & Current Events

Enterprise Products is a midstream MLP. It operates storage and transportation assets, including oil and gas pipelines and terminals. Its assets include approximately 50,000 miles of pipelines, and storage facilities with 260 million barrels of capacity for natural gas liquids, crude oil, and other refined products. It also has 14 billion cubic feet of natural gas storage capacity.

These assets have performed well for the company, by generating significant amounts of cash flow, which fuels its high distributions to investors. On August 1st, the company reported second-quarter financial results. Revenue of $8.47 billion increased 28% from the same quarter last year. Revenue has increased 27.6% over the first half of 2018. Distributable cash flow—a non-GAAP metric which describes cash flow available to be distributed to investors—rose 36% last quarter, to $1.43 billion.

By segment, the NGL Pipelines & Services division generated 20% operating profit growth for the quarter, to a record $914 million, due mostly to higher volumes and improved fees. Elsewhere, the Petrochemical & Refined Products Services segment reported 50% operating profit growth, and also reached a record for this segment.

Enterprise Products has a long runway of growth up ahead, even if oil and gas prices do not continue to rally moving forward. As a midstream operator, the company is not as highly exposed to commodity prices as oil and gas exploration and production companies. Instead, Enterprise Products operates similarly to a toll road—it operates a “take or pay” model in which customers pay fees based on volumes transported and stored. This provides a steady stream of cash flow, and there is plenty of opportunity for continued growth.

Growth Prospects

Rather than rely solely on higher oil and gas prices for growth, Enterprise has two specific growth catalysts, which are new projects and exports. Enterprise Products has already completed $800 million of growth projects so far this year, and has $4.9 billion of growth projects currently under construction. Enterprise Products retains significant cash flow each quarter, which it uses to invest in new projects. Over the first six months of 2018, Enterprise Products retained $948 million of distributable cash flow, which is available to reinvest in growth capital projects while reducing the need to raise capital externally to fund growth.

Enterprise Products is ramping up some major recently-completed projects in the U.S., such as the Midland-to-Houston system in the Permian Basin. This is a 416-mile pipeline that provides a direct route from the Midland to the Texas Gulf Coast. It was placed into full service in April 2018, and has a maximum capacity of 575,000 barrels per day. Enterprise Products is also developing the Shin Oak NGL Pipeline in the Permian, which is scheduled to be placed into service in the second quarter of 2019. The Shin Oak NGL Pipeline is expected to have a total capacity of 600,000 barrels per day.

Exports are also a key growth catalyst. Demand for liquefied petroleum gas and liquefied natural gas, or LPG and LNG respectively, is growing at a high rate across the world, particularly in Asia. For example, the International Energy Agency predicts demand for LPG in China and India will rise by 250,000 barrels-per-day and 350,000 barrels-per-day, respectively, each year. Enterprise Products itself states that between 2012-2017, Chinese and Indian LPG demand grew at 17% and 8% per year, respectively. The company’s total crude oil, NGL, petrochemical, and refined products exports currently exceed 1.6 million barrels per day. Enterprise Products has an early lead on its competitors in exports, which could be a major growth catalyst going forward.

Expected Returns

The majority of an MLP’s returns to investors is usually comprised of distributions, which is a term used similarly as dividends. Indeed, Enterprise Products has a 5.9% distribution yield, which is roughly triple the average dividend yield of the S&P 500 Index. But when it comes to MLPs, investors should be highly concerned about the safety of the distribution. During the oil and gas downturn of 2014-2016, many MLPs cut or eliminated their distributions entirely due to declining cash flow and too much debt.

Fortunately, Enterprise Products has a safe distribution and is arguably one of the safest MLPs out there. It covers its distribution with more than enough cash flow—Enterprise Products had a distribution coverage ratio of 1.5 for both the most recent quarter, and over the first half of 2018. This means the company generated 50% more cash flow than it needed to pay distributions to unitholders in both periods. Such a high level of coverage means the company has enough cash flow to raise its distribution and invest in growth initiatives.

Enterprise Products has increased its distribution for 56 quarters in a row. Looking back further, it has raised its distribution 65 times since its initial public offering in 1998. It has maintained such a long streak of distribution raises because of its excellent coverage, high-quality assets, and strong balance sheet. Enterprise Products has a credit rating of BBB+ from Standard & Poor’s, which is a high rating for an MLP, and helps the company maintain a manageable cost of capital.

Final Thoughts

Buying MLPs carries unique risk factors that investors should carefully weigh before buying. Another industry downturn could negatively impact MLPs, as will higher interest rates. But there are also reasons to like MLPs, specifically their high yields. Enterprise Products has a 5.9% yield, which is not the highest yield in the MLP asset class, but it has a secure payout. It is important to focus on the highest-quality MLPs. Enterprise Products has one of the strongest balance sheets in the industry. It also has an edge in exports, which stands to be a major growth catalyst. Enterprise Products should be able to maintain its distribution, even in another industry downturn, with the ability to raise its distribution regularly thanks to its high coverage.

The author is not long any of the stocks mentioned

 

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