On Jan. 6 Enterprise Products Partners (EPD -0.31%) announced a 3.3% distribution increase. Although well below current inflation rates, that's actually pretty good -- the prior increase was 1.1%, and the one before that was a scant 0.6%. Although the trend here is heading higher, investors shouldn't get too excited. Enterprise's distribution needs to be viewed in a different way than it has been in the past.
Ample room for hikes
The shift toward lower distribution growth at Enterprise has nothing to do with the master limited partnership's ability to pay. It ended the third quarter of 2021 with its distributable cash flow at 1.6 times its distribution rate, which is well above the 1.2 times coverage ratio that has historically been considered strong in the midstream space. That's not new, either -- distribution coverage has been well above 1.2 times since 2018.
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Nor is the slowdown in distribution growth a function of a weak balance sheet. In fact, compared to similarly sized peers, Enterprise has one of the strongest debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) ratios, at roughly 3.9 times. That's nearly a full point better than Enbridge, which is the closest peer at 4.8 times. Enterprise also covers its interest expenses by roughly 4.2 times, again better than its peers, with Enbridge coming in second at a roughly 3.9 times interest coverage ratio. Enterprise's debt is investment-grade rated, as well, so tapping public debt markets in a worst-case scenario likely wouldn't be a problem.
EPD Financial Debt to EBITDA (TTM) data by YCharts
Basically, there's no reason to worry about the current payout. And there's no particular financial reason why this North American midstream giant couldn't raise the distribution at a faster clip.
Shifting priorities
The thing is, Enterprise doesn't exist in a vacuum. It has to contend with the world around it, and things are changing, from investor desires to the ESG-driven clean energy push. Management first reacted to the midstream industry's changing dynamics by working to self-fund more of its capital investment plans. That basically saved the partnership from needing to issue units, which can be dilutive to current unitholders, and taking on more debt. Essentially, while coverage increased, more cash was being put toward other spending needs, a shift that investors in the energy patch had been broadly looking for throughout the sector.
That was the basic reason for the uptick in coverage in 2018. However, in 2021 Enterprise expects to have self-funded its investments. So it has reached its self-funding goal. But investors shouldn't expect that to materially change the distribution trend. Low-single digits is probably the best that can be expected from here. One big-picture headwind that investors need to consider is the negative view of carbon-based energy sources today.
For example, after fighting years of legal challenges, Dominion Energy gave up on its Atlantic Coast Pipeline project in 2020 despite repeated legal wins. And in 2021 TC Energy abandoned plans for the XL Pipeline after years of legal and political pushback. It has definitely gotten more difficult to build new midstream infrastructure projects in some regions. And that had long been one of the ways that partnerships like Enterprise grew. However, Enterprise operates in areas with more favorable industry dynamics, so ESG issues are a concern, but perhaps not the biggest concern. More pertinent to the MLP is that past building sprees have resulted in too much infrastructure supply. In other words, the need for new construction isn't the same as it once was.
With new construction opportunities here diminished, contractual rate increases become more important -- but they are generally pretty modest. So rate hikes aren't going to be enough to support rapid distribution growth.
The other major opportunity for growth is acquisitions. Enterprise just inked a $3.25 billion deal to buy privately held Navitas Midstream Partners. The deal shows how Enterprise can still make good use of its financial strength and industry scale -- it has a market cap of $51 billion. Management expects the transaction to immediately be accretive as well, which is very good. In fact, the extra $0.18 to $0.22 per share that the deal is projected to add to distributable cash flow could result in a sizable one-time jump in the distribution. But the takeaway from this shouldn't be that distribution growth is back, but that distribution growth could be kind of lumpy in the future.
A new frame of mind
Enterprise has historically been a slow and steady tortoise when it comes to distribution growth. Given the current backdrop and the partnership's positioning and goals, it could be an even slower tortoise that has an occasional sprinting fit. But you can't go in counting on the sprints, with really slow distribution growth likely to be the norm. That's one of the reasons why this partnership has a historically generous yield, at 7.9% or so. Basically, the yield is probably going to be the biggest piece of your returns, with distribution growth more of a background support most of the time.
