Image source: Enterprise Products Partners investor presentation.
If you look around the energy space as of late, there are growing concerns that many other midstream companies will follow in the footsteps of Kinder Morgan and cut their payouts to shareholders. Some will simply say that it is an inevitability of the midstream/master limited partnership business model, but in truth, that isn't really the case. If you need any confirmation that not all master limited partnerships share the same fate, just look at Enterprise Products Partners (EPD 1.77%)
On the company's last conference call, Enterrpise Products Partners management really went out of its way to show how they manage the company very differently than others in the space, and how that's a benefit to long-term shareholders. Here are five quotes from management that really highlight management's message.
That is how you keep a distribution safe
This recent fear of MLPs cutting payouts was really brought to the forefront when Kinder Morgan cut its dividend payment by 75% to retain its investment grade rating. Unlike others that have distribution coverage ratios in the 1.0 to 1.1 times range that were considered safe and secure, Enterprise's management wanted to remind investors that it keeps a much more sturdy payout policy than that.
Excluding proceeds from asset sales, we generated $970 million of distributable cash flow this quarter, which provides 1.3x coverage of the cash distribution that will be paid on November 6. Including the $1.5 billion of proceeds from the sale of our offshore business, we retained $1.7 billion of distributable cash flow this quarter to reinvest in the growth of the partnership and reduce our reliance on the capital markets. For the first 9 months of 2015, we retained $2.3 billion of distributable cash flow, including proceeds from sale of assets. --CEO Michael Creel
The other thing that makes this policy handy is that it greatly reduces the company's need to raise capital though equity issuances. By retaining so much cash from operations, it can reinvest in the $7 billion worth of projects currently under construction.
We've done this before
Over the past 3-5 years, master limited partnerships have been popping up all over the place as larger companies look to capitlize on their midstream assets with a MLP spinoff. Many of them were touted as having huge potential for distribution growth as those parent companies handed down more assets on top of any organic growth, but few of them have gone through multiple commodity cycles.
The ups and downs of the market are nothing new to Enterprise, and Creel wants to remind everyone that the company has managed through tough times like this before rather well:
As 2015 winds to an end, we begin to look at 2016. And we believe that current low commodity price environment may last through at least the first half of 2016. Given this lower price environment, we believe Enterprise is well positioned to manage, adapt and prosper through this cycle, as we did through the 2008 and 2009 cycle. Our business model has withstood a number of commodity price cycles, and we are confident in our ability to produce solid results while maintaining financial flexibility consistent with our BBB+, Baa1 investment-grade debt ratings, and we continue to provide healthy distribution coverage.
Maintaining that investment grade credit rating is a critical one. It means the company has much better access to the debt markets and can secure much lower interest rates than its junk-rated peers. Over a decade or two, even a single percentage point on a debt payment can mean a lot more in interest.
We're not satisfied being just a tollbooth
Many investors are attracted to pipeline space because it has what many call the tollbooth model for its business. Basically, a company that owns pipelines or other transport & logistics assets charges a fixed fee to use those assets and doesn't pay any mind to the price of the commodity moving through its system.
There are certainly some merits to this business model, but according to chief operating officer A. James "Jim" Teague, Enterprise thinks that sticking to the letter of this model isn't necessarily the best model for effectively using its system:
Obviously, margins have suffered from lower prices, but because of the integration within our systems, there also continues to be opportunities in other areas, things like our storage assets and our marketing activities. Our results are because our people are not satisfied with just being toll collectors. They use creativity and drive to capture value that's not readily apparent. An example is their relentless focus on variable cost. Rather than just focusing on throughput, they focus on efficiency. In other words, our first question used to be, how much more can you move? Can you run the units harder? Our first question now is, how efficiently can we move the product? Is it really necessary to run certain units to accomplish our goals?
Going back to the tollbooth model approach as an example, if you have a tollbooth with eight booths, and traffic is light, why keep employees at all eight lanes when you can adequately serve that amount of traffic with four? This is a generic explanation of how Enterprise runs its business, but it helps to explain how management is consistently looking for the most cost-efficient method to do business.
The power of Enterprise's corporate structure
One thing that sets Enterprise apart from many other master limited partnerships is that it doesn't have a managing general partner to which it has to pay incentive distribution rights. This wasn't always the case, though. Back in 2010, Enterprise was able to buy out its general partners' stakes' incentive distribution rights.
As Creel highlighted, if Enterprise hadn't made this move, the company's financial reports would look very different from the ones we are seeing today:
What if Dan and his family did not have the vision to cap the Enterprise incentive distribution rights in 2002 and eliminate them altogether in the third quarter of 2010? Enterprise would have paid more than $6 billion to its general partner under the IDRs since the 4th quarter of 2010, and our distribution this quarter would be 0.7x instead of 1.3x. And that assumes that we would have the same growth trajectory, the same cash distribution and the same credit ratings, and that's a big assumption.
In this quote, Creel was referring to Dan Duncan and the Duncan family, who own a 33% stake in Enterprise through Enterprise Products Company. As part of his prepared remarks, Creel noted the many steps Duncan took on the general partners side to ensure the longer-term security of the business. As you can see, the difference in distributions is pretty stark if Enterprise was still required to pay those incentive distribution rights.
Not caving into investor pressure helps in the long run
Back in 2013, or even 2014, a lot of investors might have questioned Enterprise's decision to keep a more conservative payout policy. After all, debt was cheap, and equity prices were very strong, which suggested the company could return more cash to its investors while still having plenty of financing options to fund growth.
At the same time, many of Enterprise's peers were pushing more cash out the door to investors and growing their payouts at astounding rates. Instead of giving into that pressure, Enterprise kept a considerable amount of cash in house.
Ultimately, as Creel noted, the company is in a position many other MLPs are envious of:
But if you look at what we've said about distribution coverage over the last 8, 9 years, we tend to deliver the same message. And when times are good and everything is working for all the MLPs -- and most MLPs are floating around at 1x coverage, we get the question why don't we lower our coverage and distribute more cash flows. In times like this, investors say it makes sense for MLPs to retain more cash flow. It takes the pressure off the equity markets. And now people seem to be drifting more toward our model, which has been very consistent over time. So there's one thing about it. It's we're consistent.
By managing itself with these conservative, more long-term focused principles, Enterprise is positioned to withstand this market swoon much better than others, and if the company maintains these principles, it will likely perform well in other market downturns.
