When Enterprise Products Partners (NYSE:EPD) announced that it was changing its distribution plan for the upcoming years, and even hinted that it might look at share repurchases in the not-too-distant future, some investors might have thought that meant Enterprise's days of growth were behind it. Based on the things management has said recently, that isn't necessarily the case, it just means the company is adjusting to changing dynamics in the market.
On the company's most recent earnings conference call, Enterprise's management discussed some of the major trends in both the oil and gas industry as well as some broader economic themes that are shaping some of management's actions. Here are several quotes from that conference call that will give investors an idea of how management views these new challenges and opportunities. (If you want to look at the whole conference call, check it out here.)
Pole position in Permian
Any talk about shale oil today is dominated by the Permian Basin. It has proved much more prolific than anyone anticipated, and producers have been able to reduce per-barrel costs to the point that it's rather lucrative to bring on new production even at today's lower prices. For the Permian to be the oil production powerhouse it is, it requires a massive amount of transportation, processing, and logistics infrastructure to deliver that product to end markets. Thankfully for Enterprise, its infrastructure footprint couldn't be better suited for the Permian Basin.
Here's CEO Jim Teague on the company's Permian footprint:
When you look at the map of our systems, you couldn't have put the Permian Basin in a better place. It's close to all assets all along the Gulf Coast and literally in the fairway of many of our natural gas and natural gas liquids assets. We're finding opportunities to connect the dots around our assets including expanding existing assets, converting assets and building new projects like our Orla processing complex, Shin Oak and Midland-to-Sealy crude line. We're not done finding opportunities in what is now the world's hottest basin.
With some of the world's largest oil producers placing big bets on the Permian Basin, it's likely that Enterprise and others will have lots of opportunities to leverage that Permian footprint into high-return projects for years to come.
Big bets on the forgotten parts of the oil and gas business
Oil and natural gas have been the talk of the town when it comes to America's shale revolution. What is talked about much less but could be just as important, though, is the production of oil and gas byproducts such as natural gas liquids. These products are lighter than crude oil but aren't in a gaseous state. Propane is a great example. These byproducts can serve many purposes, such as feedstock in petrochemical manufacturing because they are so cheap.
While Enterprise has always had a significant presence in these particular products, many of its investments recently have doubled down on this segment of the industry. Here's Teague highlighting one of its major projects and the potential out there for this project in the years to come:
We also announced this morning that we've entered into a 50-50 joint venture to build a new ethylene export facility around the Gulf Coast that will have the capacity to export 1 million tons of ethylene per year. These new ethylene assets leverage and extend our existing NGL and petrochemical systems and, we believe, are the beginning of the Gulf Coast ethylene distribution system.
While the folks don't realize that by 2021, just the state of Texas will be the largest producer of ethylene from steam cracking in the world, and that's not counting what is happening across the border in Louisiana. That's in our backyard, and the resulting rapid growth in ethylene combined with increased international demand for markets like Asia creates an ideal scenario in which markets abroad can diversify their supply toward cost-advantaged U.S. feedstocks.
Here's what makes these investments even more lucrative. Outside the U.S., most petrochemical manufacturing uses a crude oil byproduct known as naphtha. The price of naphtha moves in lockstep with crude oil. Natural gas and natural gas liquids in the U.S., on the other hand, are priced independently. As crude oil prices rise, it makes U.S.-based petrochemical manufacturing and processing that much more lucrative.
Rising interest rates an issue?
Pipeline & processing companies are a unique beast among publicly traded companies. It takes massive amounts of capital to build a new pipe or facility, but once that project is running, it can last for 20 to 30 years with minimal maintenance capital. As a result, these companies take on a lot of debt to start a project, because each one will throw off cash for decades.
The downside to this, of course, is that Enterprise and others are extremely sensitive to interest rates and their ability to secure debt at attractive rates. With interest rates on the rise, there is of course fear that it will eat into Enterprise's bottom line. According to CFO Bryan Bulawa, though, the maturity dates for its existing debt and interest rates are not a concern at this point:
The average life of our debt portfolio was 13.9 years assuming the first call day for our hybrids and our effective average cost of debt was 4.6%. Approximately 87% of our debt outstanding is fixed rate, thereby insulating our debt portfolio in a rising interest rate environment.
As for now, the only thing that will change at Enterprise is how the company funds future projects. Higher interest rates mean the rate of return on projects needs to be higher.
Enterprise has a reputation for maintaining a much more conservative balance sheet than most of its peers. Electing to use some funds from operations to cover capital spending rather than others that have relied on debt and equity to fund growth over the years. Recently, though, management took an even more conservative approach when it announced last year it was cutting its distribution growth rate in half to focus on funding projects. Bulawa highlighted what this will mean for the company's budget in the coming years:
[During] 2017, we funded through excess distributable cash flow or retain [sic] earnings approximately 55% of our equity funding requirements attributed to 2017 growth capital investments. We anticipate this level to continue to rise in 2018 and to reach a self-funding equity model in 2019 with $2.5 billion to $3 billion growth capital investment profile, while preserving our targeted leverage objective of 3.75 to 4 times.
The idea of self-funding the equity portion of its budget was known, but what is surprising is the company's target leverage number. Over the past few years, management has increased its target leverage -- measured as total debt to EBITDA -- to 4.0 to 4.5 times because of the immense amount of opportunities to invest in the business. Getting down to that 3.75 to 4.0 times range will put it back toward its historical levels and may also be a sign of management acknowledging the challenges of funding the business in a rising interest rate environment.
Changing its stripes
Over the past few years, we have seen a lot of companies in this industry change their corporate structure. Whether it's buying out a general partner stake in a subsidiary to eliminate incentive distribution rights or folding the entire business up into a C Corp, there is a clear trend away from the traditional master limited partnership model. When a trend starts, analysts start asking other companies if they are considering the same thing. So, of course, someone asked whether Enterprise was considering changing its corporate structure from a master limited partnership to a traditional C-Corp. Here's Vice President of Investor Relations Randy Burkhalter's response:
I think where we are I think we still feel like the MLP structure works for us as far as access to capital is concerned. Access to equity capital at a reasonable price, we'll continue to monitor, frankly, how the capital values midstream C Corps versus midstream MLPs. Frankly, we haven't seen a lot of difference over the last couple of years, but frankly there was a lot of noise in the space whether you're a C Corp or MLP over the last three years. So, I think we will continue to monitor that and see what develops on the front. But that's forever election, so it's not to be taken lightly and we will continue to come and evaluate. But we think we got good access to capital now.
It's possible that the companies that have changed from MLPs to C-Corps will see better access to capital -- ratings agencies tend to view C Corps more favorably when giving credit ratings. Maybe, just maybe, the reason those companies were struggling with access to capital is that they were carrying higher debt loads than Enterprise in the first place. As long as Enterprise's management maintains a conservative approach to funding projects and raising capital, it shouldn't matter that much whether the company is an MLP or a C-Corp. A great management team is what makes or breaks a company in this business, and Enterprise's management has proven to be excellent stewards of shareholder capital.