Even though Enterprise Products Partners (NYSE:EPD) continues to post record-breaking results on a regular basis, Wall Street hasn't been kind to the stock. Part of that likely is due to investors indiscriminately pulling out of master limited partnerships, or perhaps some are seeking greener pastures after management announced several months ago that it intends to decelerate its distribution growth.
If those same investors delved into Enterprise's most recent analyst day presentation, though, they may not be so quick to invest their money elsewhere, because Enterprise has some rather large growth plans in the works despite what its distribution growth guidance suggests. Here are three key messages that Enterprise's management delivered during its most recent analyst day presentation and what they could mean for investors.
The changing landscape
As you might expect from a company in the oil and gas business, Enterprise gave its rundown of what it's seeing as the opportunity in the market today and where it will go from here. I don't mean where prices will go, but instead, some of the less noticeable market opportunities that are likely to arise in North America.
According to management, the thing to watch the most is drilling efficiency in the U.S. and the opportunities it will create over the next few years. Their assessment is that oil production is going to grow faster than drilling activity because we are getting more and more out of each well. This is likely going to lead to supply chain bottlenecks if there isn't a commitment to a greater infrastructure build-out.
The other key component of Enterprise's overview is the growth in demand overseas for all the different kinds of hydrocarbons, and the price for some of those products will be significantly higher than in North America. While there have been other companies saying similar things, Enterprise's projections show these trends being more pronounced than others.
Our three avenues to growth
The reason for giving that 10,000-foot view of the U.S. market was that it helped frame management's thinking around its $5.5 billion in projects currently under construction. Based on the plans the company presented, all of its future growth can be lumped into three distinct categories:
- Increasing capacity to deliver hydrocarbons to the Gulf Coast.
- More petrochemical production, especially ones made from out-of-favor feedstocks.
- Export capacity.
Enterprise isn't alone in this assessment, either. During Magellan Midstream Partners' (NYSE:MMP) analyst day presentation, management highlighted that it's investing in three additional oil import/export terminals that will be capable of moving close to 2 million barrels per day. This is an example of the massive opportunities in the midstream space as the U.S. becomes an oil and gas producing powerhouse.
Responding to investor concerns
Investors who were in the market for pipelines and other midstream businesses several years ago aren't the same investors who are looking at these companies today. While many investors flocked to this industry for payout growth in the early part of this decade, that doesn't appear to be the case anymore.
Personally, I don't think this should come as a surprise to most investors. Oil and gas infrastructure is inherently a business that rewards conservatism in the long run. To grow a payout quickly in this business, you have to take risks on projects with lower rates of return and potentially return rates that are below your cost of capital. That happened too much in this business and lead to bloated balance sheets and eventually, payout cuts from the most egregious offenders. Today, investors appear to be much more concerned about the long-term sustainability of a company's payout, as well as the total-return potential of the stock.
Based on this, it's much easier to understand management's decision to lower both its distribution growth targets for the next few years and its target range for its debt levels. With slower payout growth, management intends to retain even more of its operating cash flow to fund its capital spending. In fact, it expects that by 2019, it will be able to generate enough cash that it won't have to issue equity -- something it has done to fund growth in recent years.
It may sound like a small change, but it actually has monumental consequences for investors. Share dilution to fund growth means cash from new projects is spread across a wider investment base. By electing to do away with share issuance for funding organic capital expenditures, Enterprise ultimately should deliver high per-share returns for the business over time. Management has also hinted at the possibility of repurchasing shares if all goes to plan.
What I believe
Enterprise typically has a long queue of potential projects, but this current wave of investments is especially large. Once they're complete, it wouldn't be surprising if management taps the brakes on its spending for a bit while it assesses its next great investment opportunity.
The longer your investment time horizon, the more you should like the message that Enterprise is delivering right now. Management's focusing on total shareholder returns instead of distribution growth at all costs may mean slower growth in the short term, but it significantly reduces the risk of running into financial trouble down the road.
Considering how dividend cuts have wiped out years of gains at other companies in this industry, this is the right move to make. Anyone with an investment time horizon that spans years or possibly decades should take a look at Enterprise, because management's plan is very much in line with that kind of investor.