The energy sector is facing a massive supply and demand imbalance that's thrown a giant wrench into the normal flow of business. The problems aren't going to subside for a while. Now is the time to err on the side of caution, choosing large, diversified, and financially strong energy investments. That's exactly what Enterprise Products Partners (EPD 1.30%) happens to be. Here's a review of why this midstream stalwart is worth a close look today.
1. The middle is a good place
Enterprise operates in the midstream segment, which is a key differentiator in the energy sector. Unlike upstream companies that drill for oil and gas, volatile commodity prices don't dictate Enterprise's top- or bottom-line results. Nor is it like a downstream company that refines oil and gas or makes chemicals, where earnings are driven by the difference (or margins) between its input costs and the price for which it can sell its products.
Enterprise simply owns the infrastructure that helps to move oil and gas from where it is drilled to where it eventually gets consumed. This business is largely driven by contracts and fees, kind of like a toll on a bridge. In fact, roughly 85% of Enterprise's gross margins were fee-based in 2019 (the number in the first quarter of 2020 was 88%). This important difference provides a consistency to the company's business that upstream and downstream players lack. It is, in many ways, a safer business model. For example, while earnings at drillers have been falling sharply, Enterprise's bottom line actually rose in the first quarter of 2020. Its distributable cash flow (a measure of its ability to pay distributions), meanwhile, fell by a very modest 5% or so in one of the most difficult energy markets in recent history.
2. Size and diversification help, too
Enterprise's size and reach are also key differentiators. It is easily one of the largest midstream companies in North America, sporting a $40 billion market cap, and is seen as a bellwether in the industry. Its collection of assets spans the region and would be virtually impossible to replace or replicate. And, equally important, its portfolio includes a vast array of vital infrastructure, including pipelines, storage, transportation hubs (like ports), processing facilities, and even a fleet of ships. Geographic diversification, asset diversification, and scale all add up to provide additional safety to the master limited partnership's top and bottom lines.
3. Conservatively financed
These positives, however, could be meaningless if Enterprise were a highly leveraged entity. In fact, excessive use of leverage has resulted in distribution cuts at a number of the partnership's peers in the past. Luckily, Enterprise has long taken a conservative approach to its balance sheet. To put a number on that, Enterprise's financial debt to EBITDA ratio is around 3.5 times. That's toward the low end of the industry, which is where you'll normally find the midstream giant on this measure. Moreover, it covered its distribution by 1.7 times in 2019, with first-quarter 2020 coverage of roughly 1.6 times. Remember, this is an incredibly difficult time in the energy space. Enterprise's ample distribution coverage continues to provide room for it to navigate the uncertainty in the industry without putting the distribution at risk. The yield, by the way, is over 10%, despite the strong distribution coverage, low leverage, and conservative business model.
4. It's not immune
All of that said, Enterprise does still have to work within the market it serves, and right now things are tough. So the partnership is reducing its costs as best it can, and has pulled back on its capital spending plans. The latter issue is notable because it will have an impact on future growth, effectively slowing it down.
Clearly, growing more would be better than growing less in normal times, but these aren't normal times. With energy companies retrenching by trimming their own investment budgets and even shutting down operating wells, it is prudent for Enterprise to pull back along with its customers. The ultimate impact here might be that the distribution, which has grown regularly for more than two decades, might flatline, or at the very least slow to token hikes. With a 10% yield, however, it's hard to complain too much about that.
Worth a close look
If you are watching the energy sector and think that the drop has been overdone, you should be looking at Enterprise today. It is one of the cleanest shirts in a very dirty industry, and will pay you well to stick around through the tough times. That said, it won't rebound quite as much as an oil driller would when commodity markets eventually rebalance. But this is really an income investment at heart, so that probably shouldn't upset most investors doing a deep dive here.