Enterprise Products Partners (NYSE: EPD) is one of the largest publicly traded midstream companies with a market capitalization of $40 billion. The company, with a near 10% dividend yield, offers the perfect mix of quality assets, quality management, high potential, and long returns for shareholders. At less than $20 per share, it should be the cornerstone of a quality energy investment portfolio.
U.S. Oil Market Volume and COVID-19 Collapse
The U.S. has seen COVID-19 collapse oil prices, which has caused a subsequent collapse in capital spending.
The United States already saw rig count rending down throughout 2019 as concerns emerged about the strength of oil prices. Rig counts in the United States have collapsed from a peak of 1076 in late-2018 to 279 currently. That represents a roughly 75% decline caused by COVID-19. It’s easy to extrapolate that this will turn into a collapse in oil production.
Across every major oil basin in the United States, including the Permian Basin, one of the lowest cost highest potential basins in the world, the rig count has dropped significantly. Even in primarily natural gas basins, despite remarkable strength in in demand, rig counts have dropped. That’s due to stressed oil producers dramatically cutting capital spending across the board.
U.S. Oil Market Potential and Tightening
The immediate term impacts on oil markets are quite clearly expected, and even without a significant recovery in rigs, will have a dramatic collapse in production.
Enterprise Products Partners Oil Production Forecast – Enterprise Product Partners Investor Presentation
The above image shows Enterprise Products Partners forecast of oil production versus what happened due to COVID-19 In early 2020, production peaked at nearly 13 million barrels per day and was expected to grow past 14 million barrels / day in late-2022. As a midstream company or “toll operator” that would have been a huge boon to Enterprise Products Partners.
Now oil production is expected to drop to less than 11 million barrels to late 2020. Even with oil completions doubling to 760 a month by early 2021, the recovery in production is expected to be incredibly slow to just over 11 million barrels / day in late-2022.
Oil Market Tightening – Enterprise Products Partners Investor Presentation
However, what will support long-term production growth is the tightening of the American oil market, which will support prices. For 2020 the crude oil balance over / under will be nearly 1 million barrels / day, a significant amount. However, going into 2020, that (under) is expected to be significant, even if OPEC+ halts all oil cuts.
As a significant part of this, the United States is expected to be a major supplier to the world oil. This is especially true as natural gas becomes a growing part of the world’s oil consumption. Enterprise Product Partners will become a more significant part of this – even if the next several years remain difficult for the company.
Looking into the long run, hydrocarbon demand isn’t expected to flatten out for at least multiple decades. That means the potential for many years of continued cash flow for investors in Enterprise Product Partners.
Enterprise Products Partners Financial Strength
As a toll operator, or midstream company, Enterprise Products Partners has turned its assets, despite the market difficulties, into incredible financial strength.
Enterprise Products Partners has an incredibly significant portfolio of assets with $40 billion in market capitalization and nearly $70 billion in enterprise value (prices have dropped since the above slides). The company has the highest credit rating in the midstream energy space with a BBB+ / Baa1 credit rating and an incredibly low and manageable leverage of 3.3x.
The company has >21 years of consecutive dividend increases, backed up by an incredibly strong financial position and 12% unlevered returns on invested capital of 12% over the past 10 years. The company maintains $2.75 billion in annualized growth capex with $1.78 / unit annualized distributions and 1.6x distribution coverage.
The company has a $2 billion buyback in place, which with a near 10% dividend, I’d like to see the company expand significantly. Management is significantly aligned with shareholder interests owning 32% of common units. The $8 billion in annualized EBITDA means the company can expand debt by $8 billion to be near other companies in the space, enough to repurchase 20% of shares.
Assuming the company can issue that debt at 5%, that means issuing $8 billion and buying back shares would save the company $400 million in annual cash flow. That’s incredibly significant.
Enterprise Products Partners Financial Strength – Enterprise Products Partners Investor Presentation
Enterprise Products Partners has $6.2 billion in annualized DCF and spends $3.9 billion of that on its dividends, leaving $2.3 billion annualized. The company’s revised 2020 growth capital forecast of $2.75 billion at a midpoint, is nearly completely covered. Spending 7% of the company’s market capitalization on growth, while nearly covering that is impressive.
Going into 2021 – 2022, the company expects growth capital to be $2.5 billion and $1.5 billion with reducing sustaining capital expenditures by ~$200 million. This lower capital spending is more than sustainable for the company. In fact, it will even leave additional FCF for the company. The company has maintained strong credit for the downturn with $7 billion in liquidity.
The company has continued to repurchase units and kept its distribution flat. We’d like to see the company pickup buybacks, as discussed above.
Enterprise Products Partners Capital Strength
Going post 2020, Enterprise Products Partners has significant capital strength with its investments.
Enterprise Products Partners Capital Projects – Enterprise Products Partners Investor Presentation
Enterprise Products Partners has a massive $6.9 billion in capital projects under construction, a significant part of which it has already paid Going forward, the company has a number of projects that are expected to start up, especially in 2021 onward. Many of these projects are a mix of natural gas and crude oil, with the company focused on major high potential pipelines.
The potential of this capital spending, covered by the company’s 2020-2022 growth capital spending is significant. The company has a near 80% EBITDA to DCF conversion rate. It plans to spend more than $7 billion from 2020-2022, which at a 12% return on un-levered capital means $850 million in new adjusted EBITDA. That means $600 million in new DCF.
That’s significant DCF. It enables the company to expand its dividends by 15% should it choose to do so, or the mid single digits annualized. That means the potential for higher shareholder rewards going forward for those who invest today.
Enterprise Products Partners Debt and History
Looking into the long run, what’ll define the company’s success are its debt yield and its continued execution of capital spending.
Enterprise Products Partners Debt – Enterprise Products Partners Investor Presentation
Enterprise Products Partners has an incredibly exciting debt portfolio. The company has reduced its debt yield to 4.5% with a 20.2 average yield, and 99.2% fixed rate debt. That’s an incredibly exciting and manageable debt yield and highlights the potential benefits of issuing debt in order to repurchase shares at a near 10% yield.
The company can take advantage of significantly lower interest rates due to COVID-19 to reduce its interest rates even further. A 1% further interest rate reduction would save the company $300 million annualized. However, the key thing is, looking at the validity of the company’s long-term business, the company’s debt is incredibly manageable.
Enterprise Products Partners Investment History – Enterprise Products Partners Investor Presentation
Enterprise Products Partners is incredibly well positioned as a company, showing an ability to maintain growth capital and continuing to invest, even at difficult times. We’d like to see the company take advantage of the downturn to invest in other smaller cap midstream companies that have had an incredibly difficult time.
It’s size has meant that it’s share price has dropped much further. The company’s continued investments in organic growth capital along with a manageable debt portfolio defines a history of strong execution that should continue going forward.
Enterprise Products Partners Shareholder Returns
Putting this all together, Enterprise Products Partners, with its cash flow profile, should be able to generate significant shareholder returns. We discussed above the company’s incredibly strong asset portfolio, history, and manageable debt portfolio. That combines with an incredibly strong financial position and a dividend near 10% with a multi-decade increase.
Enterprise Products Partners’ incredibly long history of increasing its dividends is a testament to the company’s strength. We feel that the company’s potential for shareholder returns are very strong. Going forward, we expect 5% annualized dividend growth combined with a near 10% dividend yield. We expect continued share buybacks on the order of 2-3% a year.
In total that means the potential for double-digit annualized shareholder returns on a growing basis.
Enterprise Products Partners Risk
Enterprise Products Partners risk posed to investors is the risk of a collapse in oil prices causing a much larger collapse in oil volumes. As we discussed above, COVID-19 has already caused a size-able collapse in U.S. oil volumes that are expected to continue. Fortunately, in the immediate term, that’s acceptable because it’s expected to cause a recovery in oil prices.
However, further volume declines could mean, when the time comes to renew contracts there’s less demand on the company’s assets. Not all pipelines are created equal and the company’s assets are incredibly well located. However, it’s still a concern that investors should pay close attention too as the leveraged company might need to cut dividends if income drops.
Enterprise Products Partners is an impressive company with a near double-digit dividend yield, significant investment in growth, and continued share buybacks and dividend raises. If all of that wasn’t enough, the company also has ample liquidity to handle the COVID-19 related price collapse and one of the best debt profiles of the large midstream companies.
These things together make the company a powerhouse, one that is an incredibly good investment. We recommend taking the opportunity to invest at current times. There is some risk that oil volume collapses will pressure the company long-term, without a recovery in capital expenditures, but in the immediate term we expect it will support prices leading to a recovery in prices and capital expenditures.
Let us know what you think in the comments below!
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Disclosure: I am/we are long EPD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.