The worst oil crash in decades has made clear some very important lessons about the great business models of midstream operators such as Kinder Morgan (KMI -0.11%) and Enterprise Products Partners (EPD 0.56%). However, after examining the latest earnings results from both companies, I think it's clear there are three reasons Enterprise Products Partners has the advantage when it comes to being able to sustainably grow its payout during a protracted period of low energy prices.
Enterprise has the more conservative distribution profile ...
| Pipeline Operator | Yield | TTM Distribution Coverage Ratio | 5-Year Payout Growth Projections |
|---|---|---|---|
| Enterprise Products Partners | 5.6% | 1.87 | 5.9% |
| Kinder Morgan | 7.5% | 1.14 | 6% to 10% in 2016, 10% 2017-2020 |
Data sources: earnings releases, Yahoo! Finance, Fastgraphs.
Kinder Morgan is trading at a much higher yield than Enterprise Products Partners because its shares have taken more of a beating in 2015.
Both companies have tollbooth business models, in which long-term, fixed-fee contracts ensure recurring and stable cash flows with very little exposure to commodity prices. Kinder Morgan's shares have fallen more this year because of concerns over whether the company can live up to its previous dividend growth guidance.
Enterprise, on the other hand, doesn't offer distribution growth guidance. Rather, it's known for its slow but steady record of 45 straight quarterly payout increases. The major component of Enterprise's success is its focus on maintaining a large distribution coverage ratio, or DCR. This focus allows it to retain vast amounts of excess cash to protect and grow its payout despite the inherent volatility of energy prices.
Source: Enterprise Products Partners investor presentation.
Kinder Morgan was counting on its enormous growth project backlog to generate substantial cash flow growth. However, low oil prices have hurt its CO2 and Canada business units and forced the postponement of some of those projects.
In addition, Kinder Morgan's coverage ratio has declined over the past year, resulting in a decreasing cash cushion. For example, in Q3 2015, Kinder generated a DCR of 1, retaining just $19 million in spare cash.
In fact, Kinder Morgan has been able to retain only $564 million over the past year. Enterprise's larger DCR of 1.3 allowed it to retain $1.7 billion in the past quarter alone, and $2.6 billion over the past 12 months.
... which means better financial flexibility ...
That excess DCF isn't just sitting in a vault protecting the payout. Each company is using it to help pay down debt and fund growth projects. Thus, Enterprise Products Partners' much larger coverage ratio is a major competitive advantage, because it helps the MLP grow without having to tap the equity markets as much.
Kinder Morgan founder and Executive Chairman Richard Kinder recently told analysts that Kinder's share-price decline has effectively closed off the short-term common equity market for the company. According to Kinder CEO Steve Kean, the company plans to avoid selling common stock through at least mid-2016.
Instead, it appears that Kinder Morgan will raise growth capital through selling preferred shares. In fact, Kinder recently sold $1.6 billion in mandatory three-year convertible preferred shares at a coupon of 9.75%.
Normally, companies use preferred convertible stock to obtain lower cost financing. Since the shares can be converted to regular stock in the future, investors are often willing to pay more for such shares, resulting in a lower yield. However, since Kinder's offering has a mandatory convertible clause, it was forced to issue the shares at a much higher coupon than even its own shares are yielding.
Then again, Kinder's balance sheet is currently so bogged down with debt that it really didn't have much choice.
... and a stronger balance sheet that can ride out the oil storm
| Company | Total Debt | Debt-to-EBITDA Ratio |
|---|---|---|
| Enterprise Products Partners | $22.5 billion | 4.7 |
| Kinder Morgan | $42.7 billion | 5.8 |
Data sources: earnings releases.
Credit agencies start getting nervous once a company's debt-to-EBITDA ratio starts going over 4.5. To preserve its investor-grade credit rating, Kinder will probably need to keep selling preferred equity, since that won't raise its debt levels.
Enterprise Products Partners, on the other hand, has plenty of liquidity available -- $4.7 billion to be precise. That consists of $5.5 billion via two largely untapped credit facilities, and its existing unrestricted cash on hand.
Takeaway: Enterprise's more conservative approach gives it an edge in a world of cheap energy prices
Enterprise Products Partners has $7.8 billion in growth projects scheduled to be completed through the end of 2017. Given the enormous quantities of excess cash it generates each quarter, as well as its stronger balance sheet, Enterprise is likely to have an easier time financing its long-term growth plan than the more leveraged Kinder Morgan.
That, in turn, should make it easier for Enterprise to keep its impressive record of distribution increases alive no matter how long low oil prices last.
