The steep collapse in oil prices over the past year has sunk stock prices across the energy sector. In many cases, there is good reason for this, as energy companies in the exploration and production industries are highly reliant on supportive commodity prices. But the oil crash is claiming undeserving victims as well -- namely those in the midstream business.
Midstream energy companies like Enterprise Products Partners (NYSE: EPD) own and operate oil and gas infrastructure, including pipelines and storage terminals. As a result, these companies are not tied to the price of the underlying commodity. Stock prices across the energy sector are going down indiscriminately, but here's why well-run midstream business Enterprise Products Partners will be just fine.
The beauty of the midstream model
Whereas upstream companies need high commodity prices to make their exploration and production activities profitable, midstream companies can do well even in a low-price environment. That's because Enterprise Products collects fees based on volumes, similar to toll roads. The beauty of this model is that it allows for a very reliable flow of cash from year to year, regardless of the direction of commodity prices.
In the following chart, you can see how steadily Enterprise Products has grown operating cash flow over the past five years.
This year, Enterprise Products' unit price has declined significantly, but the underlying company has not suffered all that much. Distributable cash flow through the first six months of the year totaled $2 billion, flat with the year-over-year period. The reason for this is that volumes held up very well, despite the crash in commodity prices. For example, its crude oil transportation volumes rose 15% last quarter, to 1.5 million barrels per day, which resulted in 28% operating profit growth in Enterprise Products' crude oil pipelines business. Similarly, operating profit in the petrochemical and refined products segment rose 12% last quarter, due to 9% growth in transportation volumes of refined products and petrochemicals.
Enterprise Products' success allows the company to regularly increase its distribution. In fact, last quarter, the company increased its distribution for the 44th consecutive quarter. The new distribution totals $1.52 per unit on an annualized rate; 5% higher than the distribution this time last year. And, investors can be confident that the distribution is safe. Enterprise Products covered its distribution last quarter with 1.3 times as much distributable cash flow.
Stock drop creates an excellent buying opportunity
If anything, long-term Foolish investors should give thanks to the market for once again acting irrationally. Investors are bailing out of anything oil-related, but the midstream pipeline companies are not getting nearly as ravaged right now as their upstream counterparts.
Enterprise Products' price has declined to around $28 per unit, down from $41 per unit at its 52-week high. That represents a stunning 34% decline from its recent peak. Considering its fundamentals have held up very well, such a huge drop seems overdone.
The good news is that this has created a fantastic buying opportunity, because the distribution yield is now tantalizingly high since prices and yields are inversely related. At its recent closing price, Enterprise Products offers close to a 5.5% yield.
This represents the highest yield Enterprise Products has seen for the past year, and by a significant margin compared to where the yield was just a few months ago. Considering the distributions will likely only continue to grow from here, it becomes apparent that this is a worthy addition to any income-oriented portfolio.