High-yield oil and gas partnership Enterprise Products Partners LP (EPD 0.56%) recently announced a "small" change in its distribution policy that will have a big impact on the partnership's future. The next year or two will likely be less rewarding than the past, but for conservative investors, Enterprise is working to become an even safer income option. Here are some things you need to know to decide if Enterprise is a buy for you.
The slowdown
Enterprise is a favorite of conservative income investors partly because it offers a 6% distribution yield, compared to the market's rate of around 2%, backed by a largely fee-based business, and also because it has increased its quarterly distribution for an impressive 53 consecutive quarters. The partnership's increase has averaged around 5% a year over the last decade.
Image source: Getty Images.
However, when the company announced its fourth-quarter distribution, it discussed a change to its distribution policy. The quarterly increase was just 0.6% compared to an increase of 1.2% the previous quarter. That's a major slowdown in distribution growth, and, according to management, "[W]e plan to recommend to our board that we continue this level of quarterly distribution growth, $0.0025 per unit per quarter, for 2018 as well." The plan is to reassess the policy when 2019 rolls around.
In other words, expect that mid-single-digit distribution growth rate to slow down into the low single digits for at least a year, and maybe longer. If distribution growth is important to you, then you'll be better off looking at a midstream partnership like Magellan Midstream Partners, LP (MMP), which is targeting 8% distribution growth in 2018. The yield at Magellan is lower, at a still robust 5%, but higher distribution growth and a conservative financial profile make it appropriate for risk-averse investors seeking income growth.
Why bother with Enterprise?
Even though many investors would be better off owning Magellan for distribution growth, there are still reasons to consider Enterprise. For starters, the logic behind the slowdown in the rate of its distribution increases is that it will allow Enterprise to self-fund more of its growth. One of the ways a partnership pays for the capital investments that allow it to increase distributions is to sell new units. To put a number on that, Enterprise's unit count increased roughly 20% between 2012 and 2016.
New units, however, dilute existing unitholders. Slowing down distribution growth will allow Enterprise to put cash that would have gone to distributions toward funding growth projects. Once new projects start to come on line, there will be more cash floating around to fund capital investments. At that point, distribution growth can tick back up to the mid-single-digits again. And the future will include less dilution because Enterprise will have shifted toward a self-funding model. Magellan, for reference, already uses this approach -- its unit count was basically flat between 2012 and 2016 despite notable business growth and double-digit distribution growth.
Enterprise's asset base is massive, and the map doesn't even show its fleet of tankers. Image source: Enterprise Products Partners LP.
So Enterprise is working toward a better future. What about now? The big things that Enterprise has over Magellan and just about every other competitor are scale and reach. Enterprise is a $60 billion-market-cap Goliath. It has operations across North America, with exposure to pipelines, ports, storage, processing, and even shipping via a fleet of tanker ships. While the larger a business is, the harder it is to expand, Enterprise also has more levers to pull to keep the business growing, in good times and bad. And there are more businesses to offset weakness if one area of the portfolio is struggling. For reference, Magellan's market cap is $16.5 billion and it is focused mainly on oil and refined product pipelines.
Don't count Enterprise out
There are options in the midstream space that offer large yields and faster distribution growth than Enterprise. However, for conservative income investors, Enterprise's 6% yield and the plan to work toward a self-funding business model should still be enticing. That's especially true given the 1 percentage-point yield advantage the units offer over a partnership like Magellan, which is already self-funding much of its growth spending.
Equally important, however, are the scale and diversification that Enterprise provides. There are few competitors that can match its size and reach in the midstream space. The move to limit the use of unit issuances to fund growth will make it a more desirable investment once this transition is complete. For risk-averse investors seeking a high yield, Enterprise is a worthwhile buy even though you might have to accept low-single-digit distribution growth for a year or two. The long-term benefit will likely be well worth the near-term distribution growth slowdown.
