Oil prices have plummeted, taking the entire energy industry down with them. But not all energy players are the same, so the broad-based downturn could actually be an opportunity for those willing to be selective.
The best part is that even some fairly conservative names in the industry have been hit by massive price declines -- which is why risk-averse investors will want to take a look at Enterprise Products Partners (EPD 0.18%) and its over 10% distribution yield today.
Happily stuck in the middle
The broader energy industry spans three main areas: drilling for oil and natural gas (upstream), pipelines and other systems that move these fuels (midstream), and the chemicals and refining space (downstream). They are all tied together, for sure, but they have different dynamics.
For example, the ups and downs of oil prices can have a massive impact on an upstream company's revenues and earnings. Meanwhile, midstream players often work off of long-term contracts and get paid for the use of their assets, not the value of what's going through them. Master limited partnership (MLP) Enterprise is focused on the midstream space and downstream assets with fee-based operations. In total, roughly 85% of its gross margin is derived from fees. Oil prices are important, but not the driving force of its business.
Image source: Getty Images.
Even though Enterprise is very different from an oil driller, investors don't seem to care about the subtleties here -- everything related to the energy sector is getting tarred with the same brush. Enterprise's units, for example, are down around 45% from their highs of the year. That drop has pushed its distribution yield up into the double digits. That's historically high for this partnership. The only other times the yield has been this high was during the 2000 tech crash and the 2007 to 2009 recession. Note, too, that Enterprise has increased its distribution annually for more than two decades -- a span that includes both of the periods just noted.
Digging a little deeper
That's just the start, however, because there's more to like here than just a general business model, distribution history, and unit price decline. For example, Enterprise recently highlighted that its customer base is made up largely of investment grade credits (68%) or customers that have been backed by a letter of credit (13%). Management has stated that even if every customer were to be downgraded two credit quality notches, 77% of its customers would still fall into those two categories.
In other words, even in a really bad energy market, the vast majority of its customers are likely to survive and keep paying. And even if a small number do go out of business, producing energy properties are more likely to change hands than simply shut down. So Enterprise's business is likely to hold up reasonably well, perhaps having to renegotiate contracts, even in a worst case scenario.
EPD Dividend Yield data by YCharts.
Meanwhile, Enterprise is one of the largest and most diversified midstream players in the industry. Its collection of assets would be nearly impossible to replace or replicate. And, equally important, what it owns is vital in the process of getting from the drill head to the end customer. Yes, an industry downturn could hurt Enterprise to some degree. That's likely to show up on the growth front, where Enterprise has stated it is reevaluating its capital spending plans. But as long as oil and natural gas are still moving through the system (and there's no indication today that oil and natural gas are going to be quickly replaced by alternatives), Enterprise has a vital role to play and should generate ample cash to keep returning value to unitholders via a hefty distribution.
That distribution, meanwhile, looks like it is on fairly solid ground. In 2019, Enterprise's coverage ratio was roughly 1.7 times. That gives it ample room to continue paying at the current level, even if it has to deal with some top line headwinds. Note that it mentioned increasing its distribution in the same news release in which it noted that it was reevaluating its capital spending plans. That's not something you'd expect to see from a management team concerned about its ability to support its payout.
Meanwhile, the balance sheet also remains strong. The partnership's financial debt to EBITDA ratio at the end of 2019 was around 3.5 times. That's toward the low end of the midstream sector, which is where Enterprise normally resides. So there's no reason to think that leverage will force Enterprise into a position where it has to cut its disbursement. In fact, it's far more likely that it could, if it had to, lean on its balance sheet to muddle through this rough patch.
Adding it all up
When you step back and look at the entire picture, Enterprise doesn't look quite as risky as the steep price decline and 10% yield might initially suggest. In fact, even conservative dividend investors might find that Enterprise looks like a relatively low-risk way to take advantage of the wider energy sector downturn.
If that sounds like you, now is the time for a deep dive. The high yield on offer here today may not last for long.
