Why You Should Buy Enterprise Products Partners L.P. for the Long Haul

Enterprise Products Partners' bullish run has not played to completion, and this may present a buying opportunity.

Feb 5, 2014 at 2:54PM

Enterprise Products Partners (NYSE:EPD), a bigwig in the midstream oil business, has received a lot of attention in the past several weeks. This is primarily in response to its record full year and fourth quarter earnings for fiscal 2014, which we reported on earlier. Just as a brief recap, Enterprise Products Partners posted an attributable net income of $2.6 billion, or $2.86 per diluted unit, on revenue of $47.7 billion, breaking fiscal year records in both cases.

Enterprise Products Partners' impressive performance in the past year is reflective of the momentum it has gained ever since the U.S. oil production boom. As expected, this has been priced into its stock. Over the past five years, Enterprise Products Partners' stock has gained well over 170% and is currently trading in previously uncharted territory. Naturally, some investors are holding back and mulling over possible scenarios; will there be a pullback? Is there more upside? Has the bullish cycle run its entire course?

While there is no blanket statement to answer all these concerns, one thing remains candidly clear; underlying fundamentals as well as wider industry and economic trends support the argument for more upside in Enterprise Products Partners.

Ability to take on more debt a plus
Enterprise Products Partners has one of the best credit ratings in the midstream sector. In October 2013, for instance, it received a credit rating of BBB+ from rating agency Standard & Poor's. This was not only the best in the midstream sector, but also qualified as an investment grade rating, which the S&P defines as anything better than BBB-.

Why is this important for investors?

Enterprise Product Partners' impressive credit rating highlights its ability to take on more debt. This is critically important as there is a huge mismatch between the current midstream infrastructure and the quantity of oil being produced. To put this into clearer perspective, around 35% of the Bakken natural gas production -- a valuable natural byproduct of oil extraction -- is flared (burned at the well) due to lack of infrastructure to store and transport it, according to the US Energy Information Administration. This wastage, caused by lack of infrastructure, runs into an estimated $100 million a month.

More transport channels need to be put in place sooner rather than later. In consideration of this, midstream companies require significantly more cash relative to the years before the production boom. However, taking this cash right out of the coffers can put an uncomfortable level of stress on cash flows. Midstream companies are thereby turning to external sources of capital. Since 2008, at the outset of the shale boom, more than 95% of midstream capital expenditures and acquisitions have been financed through equity and debt, according to a report released in November 2013 by the Deloitte Center for Energy Solutions.

Moreover, external financing to meet high capital requirements in the midstream sector is likely to continue. Shale plays are expected to keep the midstream demand momentum going over the next 10-20 years.

Clearly, the ability to source external capital (e.g. debt) needed to finance much-needed infrastructure development products is paramount. With one of the best credit ratings in the mainstream business, Enterprise Products Partners is well positioned to fill the gaping midstream infrastructure gap relative to its competitors. This will translate into more revenue and growth in the long term.

Conditions point toward a higher yield for investors
In addition to being able to seize more impending opportunities in the midstream space relative to its peers, Enterprise Products Partners greatly rewards its shareholders. It currently yields a savory 4.20%, and this could increase going forward.

Why? The Federal Reserve's decision to scale back on its monthly bond buying has led to an inevitable uptick in U.S. interest rates. Naturally, fixed-income investors have developed a liking for previously unattractive federal bonds. This has in turn led to an exodus from less attractive fixed-income plays, including emerging markets and some local equities.

In response to the Fed taper and rising interest rates, Enterprise Products Partners is likely to revise its distribution policy in favor of fixed-income investors going forward. This is because it can't afford to lose investors at such a time when pressing midstream demand magnifies the need for external capital.

More importantly, Enterprise Products Partners can revise its distribution policy more freely than its peers. This is because it is one of the few master limited partnerships in its space that does not have a general partner. General partners hold incentive distribution rights. This is an entitlement to a higher proportion of the MLP's quarterly distribution, or essentially a euphemism for management fees. Because of the lack of general partners, Enterprise Products Partners, unlike most of its peers, can get more cash to the individual investor without making radical policy changes that gnaw into its retained earnings.

Therefore, as long as the Fed continues to taper its bond buying, the more likely it is that Enterprise Products Partners shareholders will enjoy greater returns in the future. After all, Enterprise Products Partners has already set a precedent. For the past consecutive 37 quarters, it has continually increased its distribution to unitholders.

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Lennox Yieke has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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