Enterprise Product Partners (EPD +0.65%) has all the qualities investors should look for in a high-yield stock: a predictable business model; strong distribution coverage; solid balance sheet; and growth. This has allowed Enterprise to increase its distribution for 25 consecutive years.
NYSE: EPD
Key Data Points
Notably, Enterprise is structured as a master limited partnership (MLP) that issues a K-1. The tax treatment of MLP distributions is more complex, so it's best to consult a tax specialist before any investment.
So, can Enterprise continue its streak? Let's look at why there is a high probability the answer is yes.
A steady, predictable business model
Enterprise is a midstream company that transports natural gas, natural gas liquids (NGLs), crude oil, and refined products. In simplest terms, it takes hydrocarbons (such as oil and natural gas) and does everything that is needed to transport these molecules from the wellhead to a refinery, petrochemical plant, end market, or dock to be transported overseas.
Pipeline businesses are basically toll roads, where operators collect a fee for the volumes that pass through their systems. This is true of Enterprise as well, with generally 80% to 90% of its operating profits coming from fee-based activities. Fee-based midstream businesses are generally much more consistent and predictable, as they have no direct commodity price exposure. Meanwhile, about half of Enterprise's fee-based contracts are long-term take-or-pay contracts, so it gets paid regardless if its pipelines are even being used.
Image source: Getty Images.
In addition to its fee-based contracts, Enterprise benefits from a massive integrated midstream system that adds scale and arbitrage opportunities.
This integrated system benefits the company and its customers by giving them options to get the most value out of the hydrocarbons that run through Enterprise's system. This can be by upgrading a hydrocarbon to a more valuable product (such as converting ethylene to propylene), by selling it into a market with better pricing (natural gas prices are very regional), or storing a hydrocarbon to get a better future price (natural gas prices are usually higher in the winter or summer).
The combination of its fee-based business along with the optionality its system provides, gives Enterprise a very predictable business model that can withstand various commodity cycles. This leads to steady results and a less volatile stock.
Growth opportunities
While pipeline contracts typically have inflation escalators (rates rise each year based on inflation) , the biggest source of growth comes from new projects to meet customer needs. Having an integrated system helps, as Enterprise can get better returns on its investments versus building a one-off project.
The company has a backlog of $6.8 billion in growth projects with in-service dates ranging from Q1 of 2024 to the first half of 2026. It is projected to spend between $3.25 billion and $3.75 billion in growth capital expenditures this year. Enterprise has consistently gotten an 11%-13% return on its invested capital, which should lead to about $815 million in incremental operating profit a year when these projects are completed. Most of these projects are in the Permian Basin, which is the most prolific and fastest-growing oil basin in the U.S.
Importantly, Enterprise self-funds its projects through the cash flow it generates, so it doesn't have to issue stock or debt to pay for these projects. This is a huge benefit for investors, as it lowers the risk of Enterprise getting into debt troubles and potentially having to cut its distribution.
Distribution coverage and balance sheet
Enterprise currently has a distribution yield of around 7.5% with a 1.7 coverage ratio. A high ratio indicates that Enterprise has a lot of room to increase its distribution in the future, even without growth projects.
Meanwhile, the company has a solid balance sheet, ending the year with 3.0x leverage . Importantly, Enterprise has brought its leverage down over the years from 4.1x in 2017 to current levels.
High leverage and tight payout ratios can often lead to distribution cuts, but Enterprise is doing great in both these metrics, so investors don't need to worry.
Risks
When it comes to risks for Enterprise and its distributions, the biggest is the energy transition from hydrocarbons to greener alternatives that is currently underway. However, this process will likely take quite a while. Much of the transition over the past 20 years, meanwhile, when it comes to electricity generation has been a shift from coal to natural gas.
And while Enterprise does not have direct commodity risk, if energy prices fall, it can face volume risks to some of its business if its energy producing customers pull back on their drilling plans.
Conclusion
Enterprise has been one of the most consistent midstream companies over the years, growing its distribution through various energy markets. Given its strong balance sheet, growth project backlog, and robust coverage ratio, the company looks set to continue to grow its distribution for years to come.
