Enterprise Products Partners: This 8% Yield Is On Sale (NYSE:EPD)

Enterprise Products Partners (NYSE:EPD) beat both top and bottom line expectations for its fourth-quarter due to robust volume momentum in the company’s main businesses. The core value proposition for Enterprise Products Partners relates to the midstream firm’s highly predictable cash flow that is supported by long term supply contracts with Enterprise Products Partners’ customers. Additionally, the midstream firm achieved solid distribution coverage in FY 2023 and returns a high percentage of its free cash flow to investors. I believe units of Enterprise Products Partners are an especially attractive buy right as new projects are going to contribute to EPD’s growth going forward!

Previous coverage

I recommended units of Enterprise Products Partners in November 2023 as a strong buy due to the company’s diversified asset footprint in the U.S. and increasing investments in the Permian, which is a high-potential shale production area. With a filled project pipeline and strong dividend coverage achieved in FY 2023, I believe EPD is a top income stock for investors in FY 2024 and income investors are most likely going to continue to see their distributions grow.

A Top MLP Income Play With An 8% Dividend Yield

Enterprise Products Partners delivered better than expected results for the fourth-quarter with the midstream firm reporting adjusted EPS of $0.72 per-unit, beating the consensus estimate by $0.04 per-unit, and revenues coming in $2.34B above expectations.

Enterprise Products Partners generated top results across the key metric spectrum in FY 2023 as well. The midstream firm generated $9.32B in adjusted EBITDA, a key performance metric for midstream companies with large capital expenditures, which was slightly better than the record amount achieved in FY 2022, $9.31B. The MLP’s distributable cash flow amounted to $7.60B, which was only marginally below last year’s record $7.75B. While Enterprise Products Partners did not achieve a new record in terms of DCF in FY 2023, the midstream company maintained very strong distribution coverage metrics nonetheless: distributable cash flow covered EPD’s distribution by a factor of 1.7X in FY 2023 compared to 1.9X in FY 2022.

The midstream company, which runs large pipeline networks across the U.S. that connect shale production areas with storage and processing facilities, saw solid momentum across its core businesses, driven by growth in volumes ranging from NGL to crude oil to octane.

This growth is due to strong demand from consumer end markets which has been supported by a rapidly growing U.S. economy as well as falling inflation growth rates. The biggest growth occurred in marine terminal volumes (+20% Y/Y) to 2.1 million barrels per-day and in NGL fractionation volumes (+16% Y/Y) to 1.6 million barrels per-day. In total, strong demand for energy products, in both domestic and international markets, supported Enterprise Product Partners’ transported volume growth in FY 2023.

The key value of an investment in Enterprise Products Partners going forward relates to the high percentage of fee-based delivery contracts in EPD’s portfolio which reduces market price risk for midstream firms. Enterprise Products Partners enters into contracts for the delivery of energy raw materials with its producer customers that shift the risk of the transaction, as far as pricing is concerned, to the customer. The result of this fee arrangement is that midstream firms like Enterprise Products Partners have very predictable, low-volatility adjusted EBITDA and distributable cash flows that in turn allow for a high degree of distribution visibility. About 77% of EPD’s gross operating margin was derived from fee-based contracts in FY 2023, showing a 3 PP expansion compared to FY 2022.

Filled growth project pipeline points to future cash flow growth

Enterprise Products Partners has a filled growth project pipeline that is going to add incrementally to the company’s distributable cash flow, with major projects coming online in FY 2024 and FY 2025. In total, the midstream firm had $6.8B in growth projects under development, and EPD expects to spend $3.75B on growth projects this year and $3.0B in the year thereafter. As an example, Enterprise Products Partners is building two new natural gas processing plants in order to connect the Permian basin to its transportation network and completion is expected for FY 2024.

The Permian basin is major oil and gas production area in West Texas and New Mexico which offers producers enormous production upside. Of course, the entire value chain is set to benefit from the projected growth in production for crude oil, NGLs and natural gas as midstream firms like Enterprise Products Partners are required to transport these products to consumer end markets.

High free cash flow return percentage make EPD a compelling buy in FY 2024

One major reason to consider buying Enterprise Products Partners is that the midstream firm is very friendly towards unitholders and returns a lot of cash from its operations to them as distributions, but also, to a smaller extent, as unit buybacks. In 2023, Enterprise Products Partners had free cash flow of $4.8B of which the midstream firm returned a massive $4.5B to unitholders — $4.3B (96% in dividends) and $200M in unit buybacks (4%). The total free cash flow return percentage in the last year was 94%. Going forward, I expect at ~90% or higher FCF return percentage. I could even see EPD double down on unit buybacks if the company’s new gas processing plants make a positive free cash flow contribution.

Valuation of EPD vs. other midstream companies

Enterprise Products Partners’ main attractive feature right now is its valuation. The MLP’s high percentage of gross margins derived from fee-based delivery contracts, filled growth project pipeline and high distribution coverage are also reasons that favor an investment in EPD, but the valuation for me right now is the biggest reason to buy into the midstream firm.

I use an EBITDA-based valuation ratio here because midstream firms spend a lot of capital on maintenance and growth capital which has an outsized effect on earnings. Units of Enterprise Products Partners are valued at an enterprise-value-to-EBITDA ratio of 8.9X and the company is expected to deliver low single digit EBITDA growth next year. Enbridge (ENB) is growing faster with an estimated growth rate of 9.5%, but Enbridge is also more expensive because of it: Enbridge’s Enterprise-Value-to-EBITDA ratio is 10.6X. I rate Enbridge a strong buy due to the safety of the yield and its EBITDA/DCF growth.

Kinder Morgan (KMI) has a much lower valuation ratio based off of EBITDA, 4.7X, due to the company’s more unreliable dividend growth history. Kinder Morgan, however, has made progress in terms of deleveraging, but the yield has most recently risen to 7%… and KMI has acquisition potential.

Given the stability of its EBITDA and high dividend coverage, I believe EPD could reasonably trade at 10X EBITDA which implies approximately 12% upside to Friday’s closing unit price. This would put EPD’s fair value to about $29 at which point I would consider down-grading my rating to hold.

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(Source: Author)

Risks with Enterprise Products Partners

The biggest risk for Enterprise Products Partners relates to its ability to grow its distributable cash flow organically. With an enterprise value of almost $90B, real growth can only come from acquisitions at this point. Acquisition-driven growth can turn out to be expensive if synergies are overestimated and if companies overpay for acquisitions. The midstream firm is also investing in a number of growth projects in the Permian and in Texas which assume that demand for gas processing will remain high. A drop-off in demand could potentially negatively affect plant utilization in which case the company may not be able to grow its key metrics.

Final thoughts

Enterprise Products Partners is a well-run midstream firm that is seeing volume momentum in all its core businesses. While the company did not exceed its record FY 2022 results in terms of distributable cash flow, the 1.7X distribution coverage ratio, robust EBITDA and reasonable valuation make EPD a top holding for income investors. The filled growth project backlog also implies that Enterprise Products Partners will grow its distributable cash flow in FY 2024. I believe that the 8.1% yield is exceptionally attractive for investors given EPD’s distribution growth history and high free cash flow return percentage!