Enterprise Products Partners L.P. (NYSE:EPD) made a surprise announcement in late 2017, forecasting a slowdown in its distribution growth in 2018 and maybe even in 2019. Spectra Energy Partners, LP (NYSE:SEP), meanwhile, was tangentially involved in a big merger that could have significant long-term implications for the partnership. To decide which of these two high-yielders might be right for you, you need to understand what happened, why, and what it means for the future of these partnerships.
Paying its own way
Limited partnerships like midstream oil- and natural-gas-focused Enterprise are designed to throw off cash to unitholders via distributions. It's one of the big appeals of the partnership structure. However, this also means that there's less money available to reinvest in the business. That means these entities usually have to tap the capital markets via the sale of new units and the issuance of additional debt to raise the money they need to grow.
There are problems with each strategy. For example, additional debt can increase a partnership's leverage. For the most part, Enterprise is conservatively run and has a fairly modest level of leverage relative to the broader midstream group. Unit sales, meanwhile, dilute current unitholders. Enterprise's unit count has increased a notable 14% or so over the past five years. Management wants to change that by reducing the distribution growth rate in 2018, and perhaps longer, to free up more internal cash that it can use to fund growth projects.
Once those projects start to come on line, it will then have more leeway to increase the distribution and self-fund growth. In the long run, this will make the conservatively run midstream partnership a more compelling investment option. However, over the near term, it means that its long-term distribution growth will likely fall from around 6% or so (roughly double the historical rate of inflation growth) to something in the range of 3% to 4%. The 21-year streak of annual increases is set to keep growing, but just at a reduced rate while it shifts the way it supports its growth plans.
In the end, Enterprise and its roughly 6.8% yield is still a solid option for conservative investors. But it won't be quite as rewarding over the next few years as it once was for those focused on income growth. When the revamp is complete, however, investors should be looking for a return to higher distribution growth rates. How long you have to wait for this to happen, though, is still unclear.
What happened to your parent?
The big news at Spectra Energy Partners in 2017 didn't directly involve the partnership. Its general partner Spectra Energy was purchased by Enbridge Inc (NYSE:ENB). Although nothing about Spectra Energy Partners' assets and operations changed, that acquisition effectively resulted in Enbridge becoming Spectra Energy's new parent. This wouldn't have been such a big deal if Enbridge Energy Partners, L.P., also controlled by Enbridge Inc, hadn't decided to trim its distribution in 2017 after undertaking a strategic review of its business.
Income investors may understandably have had some concerns about the change of control. However, any fears have so far proven unfounded. Spectra Energy Partners continued increasing its distribution each quarter following the change in its general partner. The annual streak is now up to 12 years (and counting). Equally important, Spectra Energy's outlook for distribution growth hasn't materially changed. It is looking to increase distributions by 7% in 2018 and as much as 6% a year in 2019 and 2020 based on capital spending plans of roughly $2.5 billion between 2018 and 2019.
When announcing these projections, however, Spectra Energy noted that distribution growth could tick higher if it acquires new assets, including from its parent Enbridge. This highlights a notable difference between Enterprise and Spectra Energy: Enterprise internalized its general partner and has no parent overseeing its operations. A supportive parent can materially increase a partnership's growth prospects via dropdowns (asset sales). Enterprise has to find its own deals.
But just how supportive will Enbridge be? Spectra Energy isn't the only partnership it oversees.
So far, it looks like Spectra's new parent intends to be a positive force. For example, shortly after acquiring Spectra Energy's general partner, Enbridge offered to sell its incentive distribution rights to Spectra Energy, a move that would reduce Spectra Energy's long-term cost of capital. That deal was completed in early 2018 at a cost of roughly 172 million new units. Over the near term, that should be a drag on per-unit metrics, but the long-term benefit of a lower cost of capital should be worth the expense.
And since Spectra continues to back its distribution growth projections, there appears to be little material impact for income investors. Note, also, that Spectra, like Enterprise, is an investment-grade entity. That said, its debt-to-EBITDA ratio is higher than Enterprise, but not dramatically so. All told, it doesn't appear to be a materially riskier option in the midstream space even though Spectra Energy's yield of 7.5% is notably greater than the yield investors can get from Enterprise, and it has higher distribution growth prospects.
Distribution growth has the edge
Unless you are a particularly conservative investor, Spectra Energy Partners looks to have the edge right now. That's backed by what appears to be a supportive parent with a portfolio of assets that can be dropped down to Spectra to fuel distribution growth beyond current projections. That's not to suggest that Enterprise is a bad choice, just that it is likely to be a less-rewarding option until it gets through its current transition period.