enterprise

Could Enterprise Products Partners Be Contemplating A Move Into Renewable Energy?


Enterprise Products Partners (EPD) remains a buy after the market’s relatively muted response to its record-smashing Q2 and bullish growth guidance. It is difficult to find a safer yield north of 6% that also boasts such strong growth prospects. Additionally, there is reason to think that management may be plotting a move into the renewable energy asset space in the not too distant future depending on how economic forces play out.

Safety

As of Q2 end, EPD’s balance sheet remained top-tier for the midstream MLP sector. While total debt principal outstanding was high at $26 billion, the average length to maturity was very safe at 14.6 years at an attractive weighted average interest rate of 4.5%, 89% of which was fixed rate. Furthermore, the consolidated leverage ratio remained under 4x (3.9), which is considered very conservative, especially when considering the well-laddered maturity profile and consolidated liquidity of $3.6 billion.

Management also projects to reduce its average interest rate by soon redeeming over half a billion dollars worth of junior floating rate debt with a current effective interest rate of 6.066%. Given that the interest rate is floating and is currently higher than the equity distribution yield, this seems to be a very prudent allocation of capital and is expected to result in annual interest savings of approximately $19 million net of the interest cost of debt raised to finance this debt redemption.

Most impressively, EPD retained nearly half a billion dollars of cash flow during Q2 and nearly one billion dollars in the first half of 2018. This has enabled them to continue avoiding ATM equity issuances (last used in July of 2017), thereby preventing unit holder dilution and further securing the distribution’s safety. Furthermore, by funding ~54% of entire growth CapEx in Q2, these retained cash flows also minimize the necessity to issue new debt. As new, self-funded growth projects come on line and begin cash flowing in the coming months and years, this percentage should increase even more.

This high level of retained cash flow also means that distribution coverage remains at ~1.5x, implying significant safety and growth prospects moving forward.

Growth

While the aforementioned strong growth in DCF/unit due to self funding should result in continuing quarterly distribution raises, there are even more exciting growth prospects ahead for EPD.

EPD continued building its dominant market position within the industry as it set numerous operational records in Q2: 3.41M barrels/day of NGL transportation volumes, 0.6M barrels/day of NGL terminal volumes, 0.2M barrels/day of ethane marine terminal volumes, 0.9M barrels/day of NGL fractionation volumes, 2M barrels/day of crude oil transportation volumes, and 0.8M barrels/day of crude marine terminal volumes. Combined NGL, crude, petrochemical, and refined marine terminal volumes set a record 1.75M barrels/day, while propylene production was 19.3M pounds/day. Combined NGL, crude, petrochemical, and refined products transportation volumes were 6.2M barrels/day. Finally, NGL, crude, petrochemical, refined products, and natural gas transportation volumes were 9.8M barrels/day. Unsurprisingly, these production records yielded a record $1.4B of DCF from operations, while adjusted EBITDA was a record $1.8B. All told, EPD set a combined 14 operational and financial records during the quarter.

Looking ahead, EPD has no intention to rest on its laurels as it announced numerous new growth projects during Q2, further fortifying its competitive positioning in existing businesses and regions while extending its value chain into primary petrochemicals. It is enhancing the productivity of its first plant at Orla by constructing two more, which should give it economies of scale in the area. Furthermore, it is enhancing the productive capacity of its Chinook NGL pipeline and Mont Belvieu assets by acquiring all of the Alpine High NGLs from Apache in the Permian Basin. Additionally, EPD launched a 50-50 JV with Energy Transfer (ETP) to resume service on the long-time idle Old Ocean natural gas pipeline in addition to purchasing an additional 65 acres adjacent to the ship channel marine terminal. Finally, to further tap into export growth, EPD announced the development of an offshore crude oil export terminal in the Texas Gulf Coast.

Even more interesting, though, was management’s repeated mention of “strengthening the durability of the partnership” on the earnings call, yet with little clarity given:

With this level of financial flexibility, we can’t help to be excited by what the future holds given the amount of opportunities that are under development to further strengthen the durability of our partnership.

What “opportunities” are under development? They shot down hopes of significant unit buybacks during the earnings call, and also seemed to imply that they plan on modest quarterly distribution raises for this year at least, and potentially beyond depending on circumstances. Given those statements despite their significant cash retention, it appears that something else significant is in the works that would be aimed directly at a much longer term perspective for the partnership.

I posit that one of the options they could likely be considering is renewable energy assets. Given that the current boom in the midstream space is projected to go on for at least several more years, now is the perfect time to begin establishing a foothold in the renewable space so that when the growth opportunities in the midstream business begin drying up, they will be established and ready to invest significantly in renewables. Given their self funding status, very strong balance sheet, and increasingly robust DCF growth outlook for the next several years, they should have no issues funding an initial foray into the space.

This is not pure conjecture either: I recently heard from a gentleman who attended the Orlando MLP Association conference back in May. He mentioned that EPD’s COO acknowledged that they are indeed evaluating acquiring renewable energy assets as a potential opportunity depending on market conditions. This move would also make sense given their geographic focus in Texas and the Midwest, where there is plenty of open flat land and sunshine that are ideal for wind and solar farming. However, it is highly unlikely that they would dive in headfirst given that renewable asset valuations are fairly rich and they are still tightening up their self-funding model while continuing to capitalize on the midstream boom. Still, it would not surprise me at all if they begin making a small foray into the renewables industry over the next couple of years.

If they did go this route, I doubt it would have an enormous immediate impact on the unit price given that their investments would likely be muted. However, it would be a further sign that – as Morningstar likes to put it

While many other midstream operators are playing checkers, Enterprise Products Partners is a chess master.

By giving EPD an alternative place to deploy capital, it would further diversify EPD’s income streams and enhance opportunities for accretive growth investments while making it less dependent on commodity pricing and give it a much longer growth runway. The potential downside is that they would be leaving their circle of competence, hence why they will likely move in to the space slowly in order to build up competence and a base of operations.

Valuation

As management pointed out, EPD’s DCF/unit has grown 26% and its distribution has grown 11.7% over the past three years while its balance sheet and moat have strengthened through achieving self-funding status and a much more robust collection of assets, yet its unit price is only up 2% during that time frame.

Chart

EPD

data by

YCharts

Mr. Market truly appears frightened by the midstream sector and interest rates, though many of those fears don’t apply to EPD due to its self funding model and very strong balance sheet. If EPD diversifies outside of the MLP industry, perhaps Mr. Market will ease up on the business. Regardless if short term unit price stagnation persists or not, EPD’s 6% yield and strong growth profile are poised to deliver outsized returns over the long run as distributions continue to grow, the balance sheet remains strong, and self-funded growth continues at a strong pace.

Investor Takeaway

EPD remains my favorite MLP and remains a buy under $30. I am personally adding whenever the yield touches 6% or higher as I believe the risk-reward to be exceptionally strong here given the safety of the distribution and the prospect of continued strong growth.

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.





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