North American midstream energy bellwether Enterprise Products Partners (EPD) is currently offering investors a fat 9.7% yield. That's a number that should stop investors in their tracks, given that the distribution has been increased annually for over two decades. But the real question here is whether this is a huge opportunity for long-term investors or a sign that Enterprise is in trouble. Here are four key reasons why it's more likely a sign of a buying opportunity.
1. Muddling through
The energy sector is being hit very hard today because of a COVID-19-driven supply and demand imbalance. Everything related to oil and natural gas has been under intense pressure, including Enterprise. However, the master limited partnership's first-quarter distribution coverage was a robust 1.6 times, giving it plenty of room to deal with the adversity while continuing to support its generous distribution.
That's not to suggest that there won't be any impact. Enterprise is pulling back on its capital spending plans just like every other major energy company. That will mean slower growth in the future, and demand for its services will likely be relatively weak in the near term as exploration and production companies pull back. But the long-term outlook for oil and natural gas remains fairly strong, since these fuels are expected to be vital to the global energy picture for decades to come.
2. A good model
That's important here because Enterprise operates in the midstream space, meaning it owns a giant and diverse collection of pipelines, storage, transportation, and processing assets. Not only would it be virtually impossible to replicate its portfolio, but the partnership generally gets paid for the use of its assets, with roughly 85% of the gross margin coming from fees. The price of the products flowing through its system is much less important than demand for those products.
Thus, as long as oil and natural gas remain important, Enterprise has a solid foundation for its business. The near-term might be a little difficult, but this is a business built to survive hard times.
3. A solid balance sheet
That brings up the third big piece of the story here: Enterprise has a long history of operating in a conservative manner. The fact that it has a robust 1.6 times distribution coverage ratio is one sign of that. However, another is that its financial debt to EBITDA ratio of roughly 3.6 times is toward the low end of its peer group. That's exactly where it normally lives. So not only is the company's business model robust, but so is its balance sheet.
4. Attractive valuation
And that leads the story all the way back to the fat distribution yield. At nearly 10%, Enterprise's yield is near the high end of its historical range, suggesting the units have been dropped onto the sale rack. The last time the yield was this high was during the 2007-to-2009 recession. To be sure, there are different risks facing the partnership and energy sector today, but Enterprise looks well-positioned to deal with the headwinds and come out the other side in one piece. If you can stomach some near-term uncertainty, you can collect a fat yield while you wait for the supply/demand equation in the energy sector to rebalance.
Nothing's perfect, but...
There's no such thing as a perfect investment, and Enterprise comes with its own share of warts (most notably that it operates in a deeply out-of-favor sector). However, if you can think long-term and are willing to go against the grain on Wall Street, this high-yield name might be a great way for you to invest in the energy sector while sidestepping most of the risk of volatile energy prices.