Why You Should Shy Away From Enterprise Products Partners LP Right Now

Among midstream partnerships, Enterprise is perhaps the steadiest of all names. Three attributes that come to mind are a well-covered distribution, no general partner obligations, and a very solid balance sheet. However, Enterprise's valuation has been driven up too much, and now there are better midstream options out there.

Apr 7, 2014 at 1:31PM

Over the last five years, Enterprise Products Partners (NYSE:EPD) has been a retail investor's best friend. This midstream partnership has broad exposure to several commodities and themes: increasing domestic crude oil production, steady growth in dry-gas demand, and a huge position in the increasingly complex industry of natural gas liquids.

As most pipeline operators do, Enterprise secures long-lasting contracts with upstream companies, thereby providing highly visible cash flow, which the partnership then generously distributes to shareholders. Enterprise's business structure is also very simple: There are no general partners that have distribution priority. Finally, Enterprise is one of the least levered of the midstream partnerships and often has the highest coverage ratio for its distributions.

Sounds great, doesn't it? Well, unfortunately shares of Enterprise have been loved a little too much (although one can't blame risk-averse investors for doing so). Enterprise now trades at a significant premium to several of its pipeline peers. While risk aversion is an important aspect of investing, and Enterprise probably is the 'least risky' midstream partnership there is, the safety premium Enterprise carries is overdone at this point in time. Therefore, it would be wise for retail investors to look at other pipeline partnerships instead.

Depressed yield
 Epd Ycharts

Source: YCharts

This chart illustrates the inversely correlated relationship between dividend yield and unit price. Generally speaking, the higher the price, the lower the distribution yield. A high distribution yield has often provided a floor for Enterprise's unit price; a low yield often provides a ceiling. With a yield only in the 3.9% range, I believe we are getting close to that ceiling. Enterprise now yields less than most utilities do, where pipelines have traditionally yielded more.

Alternative options
While Enterprise may be the 'safest bet' of all pipelines out there, it really isn't the best deal anymore. Thankfully, there are some alternatives which I think are better buys at this time. The first of these is MarkWest Energy Partners (NYSE:MWE). MarkWest is the largest midstream operator in the Marcellus and Utica shales. These are shale plays which span both Ohio and Pennsylvania. Unlike Enterprise, MarkWest is in a rapid growth phase because these two shale plays are in areas which previously had no midstream infrastructure. 

With all this growth comes growing pains, however. MarkWest finished 2013 with just about 1 times distribution coverage on the year, meaning its distributable cash flow fell just short of distributions. Put it into perspective: Distributable cash flow in 2013 jumped by nearly 16% compared to last year, and distributable cash flow is expected to increase another 34% in 2014. Best of all, MarkWest yields 5.3%, considerably higher than Enterprise's yield.

Another option to consider would be the partnership shares of Kinder Morgan Energy Partners (NYSE:KMP). While Kinder units do have a general partnership obligation, which means that distributions must first go to the general partner, management expects per-unit distributions to grow a solid 5% in 2014.

Kinder Morgan generally pays all of its cash flow in distributions, and so cash flow coverage for its distributions is a tight 1.01 times. However, management has a long history of delivering on its distribution promises, and this year should be no exception. Best of all? Kinder yields a very nice 7.1%. While Kinder units may be a bit riskier than Enterprise's are, that risk is more than compensated for in the valuation.

Bottom line
Enterprise has had a good run. In looking at the pipeline industry as a whole, Enterprise may very well be the best choice for income-minded retail investors who like to keep things simple. However, the premium at which Enterprise now trades is far too high in my opinion. For those who want to invest in energy infrastructure, there are a few better choices out there right now.

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Casey Hoerth owns shares of Kinder Morgan Energy Partners LP. 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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