Source: EnLink Midstream Partners
One of my favorite things is locating deeply mispriced high-yield income opportunities for our readers. That's because the recent oil crash, which has hammered midstream MLPs such as EnLink Midstream Partners (NYSE: ENLK) and its general partner, EnLink Midstream LLC (ENLC 0.80%), is a great opportunity for buying high-quality income investments at undervalued prices that could result in market thumping outperformance for years to come.
Of course, while the severe beating that MLPs such as EnLink have taken over the past year might potentially represent a great buying opportunity, it could just as well be a warning to avoid EnLink Midstream because of major problems with its underlying business model.
To help you learn how to spot the difference, let's look at EnLink Midstream's full 2015 earnings results with a focus on the three most important factors income investors need to pay attention to when deciding whether to invest in this badly beaten midstream MLP.
What earnings metrics matter most
| Metric | 2014 | 2015 | Change |
|---|---|---|---|
| Adjusted EBITDA | $377.6 million | $678.3 million | 79.6% |
| Distributable cash flow (DCF) | $301.4 million | $529.3 million | 75.6% |
| Distribution per unit | $1.47 | $1.545 | 5.1% |
| Distribution coverage ratio (DCR) | NA | 1.02 | NA |
Sources: earnings release, Yahoo! Finance.
Though midstream MLPs report earnings per unit because this is what Wall Street analysts focus on, it's not actually of much importance to investors. That's because the tax structure of MLPs as well as the capital-intensive nature of the industry result in non-cash factors that cause massive earnings volatility, representing neither an MLP's cash flow-generating abilities nor how much it can sustainably afford to pay out to investors.
Thus, adjusted EBITDA and distributable cash flow are the two key metrics to focus on. To that end, EnLink Midstream had a fantastic 2015, with phenomenal growth in both, allowing moderate payout growth. However, note how the distribution coverage ratio for 2015 still came in just above the 1.0 long-term sustainability cutoff. This is despite massive increases in cash flow, which potentially signals a problem with profitable growth in today's low-energy-price environment.
EnLink's DCF growth was mostly fueled by a combination of $883 million in acquisitions, both dropdowns from its sponsor, Devon Energy (DVN 0.19%), as well as from third parties such as Chevron.
For 2016, management is expecting adjusted EBITDA and DCF to grow about 12% and 10.5%, respectively, thanks in large part to its $1.55 billion January acquisition of Oklahoma assets from Tall Oak Midstream LLC.
Does the payout profile agree with Wall Street's bearish valuation?
- Yield: 15.3%
- 2016 DCR guidance: approximately 1.0
- 5-year analyst annual distribution growth projections: 0%
EnLink Midstream Partners' sky-high yield indicates that Wall Street thinks there's something deeply wrong with this MLP, such as no obvious short-term growth catalysts, and a distribution that balances precariously on the knife's edge of unsustainability.
But as long-term investors know, the key to market-beating returns is to recognize when Wall Street is wrong and badly mispricing an equity. Are current growth and payout concerns about EnLink Midstream justified?
Based on management guidance of 2016 DCF growth, it would initially seem not. However, always remember to take such guidance with a grain of salt, because it's based on assumptions that could prove wrong. For example, EnLink needs to generate $524 million in DCF to hit its 2016 per-unit distribution target of $1.56.
Management's DCF guidance range of $545 million to $625 million seems to provide adequate security for this payout plan, but it's predicated on having respective oil and gas prices remain between $27.50 and $60 per barrel, and $2 and $4 per MMBTU.
While crude currently trades in this range, gas prices don't. Should energy prices fall over the next year, EnLink Midstream's DCR could fall short and endanger its generous payout. Of course analyst projections could always prove far too bearish. After all, as EnLink's latest big acquisition shows, the MLP can always buy its way to grow right? Well, not necessarily.
Can liquidity and the balance sheet drive really profitable growth to prove Wall Street wrong?
Whether EnLink Midstream is worth buying comes down to just two questions: Is the payout sustainable? And can the MLP profitably grow it in the long term?
To answer the first question requires checking to make sure that EnLink's cash flows are protected by long-term, fixed-fee contracts that also ensure volume stability.
Source: EnLink Midstream Partners investor presentation.
With 95% of 2016's operating margin derived from fee-based contracts, including substantial volume guarantees from major customers such as Devon Energy, it appears that EnLink's DCF is indeed highly secure.
Meanwhile EnLink Midstream's nearly $1.1 billion in available liquidity under its $1.5 billion credit revolver seems to back up management's claim that it won't need to raise any extremely expensive equity growth capital in the short term.
However, given the 5.0 debt/EBITDA or leverage ratio limit imposed by the debt covenant connected to that facility, it's not certain that this will truly be the case. In that case, investors need to consider that EnLink Midstream's 12-month trailing cost of capital of 10.28% far exceeds its return on invested capital of 3.5% when adjusted for 2015's $1.56 billion impairment charge.
In other words, EnLink Midstream has a history of failing to grow profitably, which potentially explains why Wall Street is currently so down on its unit price.
Bottom line
Income investors need to be aware that Wall Street's apparent ridiculous undervaluation of EnLink Midstream represents valid concerns over the MLP's ability to grow profitably, given today's extremely challenging market conditions.
