I have been following Enterprise Products Partners (NYSE:EPD) for about ten years. Over that time the oil and gas industry writ large, always volatile, has seen major convulsions that have left it fundamentally changed. MLP’s, typically much more stable businesses than their exploration and production brethren, have generally seen less upheaval in their operations but huge upheaval in their shareholder bases. This upheaval has left many MLP stocks at significantly lower valuations despite admirable cash flow growth and improved balance sheets. EPD is a poster child for this dynamic.
EPD gets a lot of coverage on SA. Eight articles have been published this month alone. I last wrote about the company in September, where I discussed the company’s dominance in the NGL fractionation and export capacity. I also pointed out that at the time the unit prices were still 25% below their pre-Covid highs and speculated that the company was a perfect target for Warren Buffett to take out the public unitholders and own the company privately with the Duncan’s. While Buffett hasn’t stepped in, the stock has appreciated about 20%. Combine that with $1.38 of distributions and the units have been a great overall return. Yet the units still remain below their pre-Covid high.
While I find it ludicrous the units have failed to regain pre-Covid levels even as many E&P companies I follow like (EQT), which I wrote about last year, have appreciated considerably, the unit performance over the past five years is even more notable.
You can see in the chart below that EPD units have barely budged since this time in 2017.
The unit price doesn’t tell the whole story about valuation, course. Unit count has increased about 2% and debt has increased about $5 billion plus another $800 million of preferred shares, leaving enterprise value up about 10% since May 2017. However, cash flow has expanded dramatically. As you can see below, cash flow from operations increased from $4.5 billion to $8.5 billion between year-end 2017 and year end 2021. As important, the company was in the middle of a major capital expenditure cycle (the May 2017 and May 2022 numbers did not differ materially from the year end dates). Those investments are bearing fruit resulting in much higher EBITDA and cash flow per unit as well as lower leverage than five years ago.
That investment has also left the company with plenty of growth for the future while laying the groundwork for adding capacity at high returns on capital.
Growing Distributions in an Era of Inflation:
I have written extensively about inflation over the past year. I was early at ringing the alarm bell when many economists and pundits were calling it transitory. EPD has been one of my favorite plays for what I fear will be a prolonged period of inflation. It has simply become significantly more expensive to build energy infrastructure. The cost of steel, labor, land, and just about anything else tied to EPD’s business is higher. Not only are some of EPD’s assets irreplaceable from a strategic point of view, they would be significantly more expensive to replace from a sheer cost of construction.
Aside from replacement cost, top among EPD virtues for many investors is a high, growing, and well-covered distribution. The company deliberately slowed its distribution growth a few years ago so that it could fund its capex cycle internally. Now that we are past that cycle, I would look for either faster growth of that distribution, more capital deployed to unit repurchases, or both.
As one can see below, this company has steadily derated since the end of 2016.
Part of this valuation decline likely stems from the volatility of the energy industry. Oil and gas prices have gyrated violently, and the overall industry went through about a ten-year period where most E&P (exploration and production) and oilfield services companies produced lousy returns for shareholders. Investors now demand return of cash rather than production growth leading to better balance sheets, better investment discipline, and overall better returns from many industry participants. As a result, shares in E&P companies have performed well with oil and gas prices moving higher.
MLP’s are a bit of a different animal. Many MLP investors were income-seeking individuals. Funds have a hard time owning MLP structure because of the associated tax issues and K-1 status. Income-seeking investors don’t expect to see their investments have major price volatility. Therefore, while EPD like (CEQP) (which I just wrote about) has steadily grown its business and cash flows, the shares have been volatile. I believe this volatility has chased away many individual investors. There is also the ESG crowd, which eschews all companies tied to fossil fuels. With institutional investors not stepping in, this dynamic has created a valuation multiple decline for EPD and other MLP’s. While this dynamic is annoying for those who already own the stock, it provides an entry point for new shareholders or for current holders who want to add to their position. The market is a voting machine in the short term and a weighing machine in the long run. As highly speculative investments like many technology companies lose their froth and likely permanently impair capital, investors could circle back to companies like EPD that grow steadily and conservatively and grow their distributions. I expect this company to at least regain its pre-Covid high at some point if not recover its 2017 multiple.
Energy has gone from a sector that had been essentially left for dead to one with a new lease on life. Energy shortages worldwide are showing even the most diehard environmentalists that traditional energy is still very much needed in this world. Energy security is national security. The US is blessed with abundant energy resources, particularly natural gas and NGL’s. The major need is enough pipe to bring those resources to market. Companies like EPD play a major role servicing that need. The company has a massive footprint in an industry that is demonstrating itself as a major economic strength of the US. Combines those traits with the protection it provides in an inflationary environment, high-quality balance sheet, and exceptional management and I consider EPD a must own.