Enterprise Commodity Stock: Big Yield and Upside Potential (NYSE:EPD)
Enterprise Product Partners (NYSE:EPD) released strong quarterly results. The company is performing very well, has a fortress balance sheet, offers a good income yield that is secure in all sorts of macro environments, and yet the EPD is not expensive at present price – potentially making it the highest quality intermediary company that investors can choose.
Irreplaceable assets in high demand
The world is currently going through an energy crisis. Underinvestment in new production, due to government regulations, ESG mandates, increasing focus on free cash generation by management teams and boards, etc., has resulted in low supply growth. At the same time, oil demand has recovered strongly after the pandemic and will continue to climb in 2023 and beyond. OPEC is also flexing its muscles and many countries want to become less dependent on Russian energy supplies. Overall, this has created an environment where markets are tight and further production cuts must be avoided. This means that American producers will have to continue to produce as much as they can, both in terms of oil and in terms of natural gas. High energy prices in the United States mean that the country benefits from domestic production, while foreign markets such as Europe also depend on American energy exports, mainly for LNG. This means that the infrastructure in place in the United States that is necessary to move energy from producing areas such as the Permian Basin to end markets and/or export terminals is extremely important – without it, states United and allied countries such as in Europe would face enormous problems.
Building new energy infrastructure, such as pipelines, has become incredibly difficult, due to regulations, lawsuits, high costs of required materials, and more. This leads to a situation where the energy infrastructure spanning the United States is very large and very difficult to build – so existing assets are the only way to meet demand. This means that the companies that own and control these existing assets, such as Enterprise Products, are in a great position — their assets are worth far more than what they originally paid for when they built or acquired those assets. , and there is no foreseeable risk of obsolescence or competition. Even if a peer was willing to build a pipeline next to one of EPD’s pipes to replace it, said pipeline would most likely face gigantic obstacles, making the existing pipes in the ground very sheltered from the competition.
Most of Enterprise Products’ business is not dependent on commodity prices, as its fee-based business model does not require oil or natural gas prices to be high. But thanks to some CPI-linked contracts and renegotiation of contract rates to higher levels over time, EPD still sees increased revenue and cash flow on existing assets. High energy prices make its customers more profitable, reducing counterparty risk for business products and giving it more leeway to charge higher prices for moving goods from point A to point B because its cash-strapped customers are able to pay more than before. past.
Strong EPD Results and Compelling Shareholder Returns
Overall, this creates a great environment for US energy infrastructure players, including Enterprise Products. The company therefore, unsurprisingly, had an excellent third quarter.
Enterprise Products’ third-quarter revenue totaled $15.5 billion, easily beating estimates and up 43% year-over-year. Since commodity prices are a middle ground for some EPD business units, revenue growth at this level does not translate into similar growth in earnings and cash flow, as expenses also increase. But EPD still managed to grow its EBITDA 12% year-over-year to $2.26 billion, or about $9 billion annualized. With some operating leverage, its distributable cash flow, i.e. adjusted operating cash flow less maintenance capital expenditures, increased 16% to $1.87 billion. dollars, or $7.5 billion annualized.
Distributable cash flow is the maximum sustainable payment an infrastructure company such as Enterprise Products can make over an extended period. In this scenario, a company spends nothing on growth projects, debt reduction, or stock buybacks. That’s not usually what companies chase, and that’s not what EPD does either, but it’s still good to know that EPD could theoretically pay around $7.5 billion a year to its owners if the company only invested in maintenance, i.e. keeping existing assets. in place, without developing any or investing in growth in any other way.
Given that the EPD is currently valued at $54 billion, the company is therefore trading at 7.2 times the third quarter DCF run rate, which works out to a distributable cash flow yield of 13. 9% – the maximum theoretical sustainable dividend yield that the DPF could offer at current prices. Enterprise Products currently pays $1.90 per share per year in dividends, which equates to company-wide dividends of $4.1 billion, based on a share count of 2 .18 billion. Thus, the dividend is covered at a rate of 1.83 from the third quarter, which equates to a DCF payout ratio of 55%, and is excellent dividend coverage for a midstream energy name. such as Enterprise Products. Between this strong dividend coverage and EPD’s excellent dividend growth history — the company has increased its dividend for more than 20 consecutive years, regardless of the crisis the world was going through — we believe that EPD risks very little to lower its dividend, making it an appropriate income investment to buy and hold.
At current prices, EPD’s dividend yield is 7.7%. It’s not the highest dividend yield in the mid-energy space, but still a pretty high income yield that would allow for pretty solid total returns even without any dividend increases and price growth. of action. Fortunately, Enterprise Products regularly offers dividend increases. The latest was announced this summer and EPD also increased its dividend earlier this year. It would therefore not be surprising to see the company increase its dividend again early next year, which would keep the semi-annual cycle intact. It is, of course, also possible that EPD will revert to a one-year up cycle, but even then the January dividend announcement could sustain the next increase, as EPD has often announced its dividend increases at the beginning of the year in the past.
Enterprise Products’ enterprise value, which adds a company’s market capitalization and net debt, currently stands at $84 billion. With EBITDA forecast at just over $9 billion this year, the company thus trades at an EV/EBITDA multiple of around 9, which is far from expensive. Especially considering EPD’s stellar track record, compelling cash flow growth and fortress balance sheet – quality factors that set the company apart among names in the energy midstream – the valuation seems very undemanding. EPD’s management also seems to believe so, which is why the company has been carrying out share buybacks recently.
During the third quarter, Enterprise Products repurchased 4 million shares. That works out to an annual buyback rate of about 1% of the company’s stock, which isn’t great, but will still have a positive impact on cash flow per share growth over time. EPD has also increased buyout spending over the past two quarters. So I wouldn’t be surprised to see the company spend more on share buybacks over the next two quarters, at least when the valuation remains inexpensive. Given that EPD leverage (3.1x EBITDA) is currently at the lower end of the target range, an increase in redemptions could also make sense from a financial leverage position. , as further debt reduction is not in line with what management has signaled they are comfortable with — and as EPD already has a strengthened balance sheet with one of the lowest leverage ratios in the industry and ample liquidity, there is also no need to further reduce debt levels.
Enterprise Products is an excellent middleman in the field of energy. It has strong management, a large asset footprint that is more or less irreplaceable, its balance sheet is very strong, its cash flow is growing at an unstoppable rate, and the company is returning billions of dollars to its owners. With a dividend yield of well over 7% and considerable dividend growth potential, the EPD looks like a solid high-yield income choice. Between buyouts, organic growth and the potential for multiple expansion, EPD could also generate share price gains. If its valuation were to reach a DCF yield of 10%, which would still be far from expensive, the shares would climb to around $34, more than 30% above current levels, for example. It’s not guaranteed, of course, but it shows that the EPD has considerable upside potential on top of the attractive earnings it offers.