We are reaffirming our BUY rating on Enterprise Products Partners LP (NYSE: EPD). We expect these projects and existing assets to support future distribution growth, despite current weak energy market conditions.
The year-over-year improvement in operating profitability was largely the result of a 40% increase in NGL fractionation volumes, which was a company record.
Adjusted third-quarter EBITDA increased 2% to $2.060 billion, while total company revenue fell 13% to $6.922 billion, primarily due to lower gas processing margins and lower composite NGL prices. The consensus revenue estimate was $7.190 billion.
On an adjusted basis, Enterprise reported 3Q20 distributable cash flow of $1.647 billion, up less than 1% from the prior-year quarter. Distributable cash flow covered the distribution by a factor of 1.7. The company reported a gross operating margin of $1.993 billion in 3Q20, down 2% from 3Q19.
Our preferred metrics for evaluating EPD are adjusted EBITDA, distributable cash flow, and gross operating margin. Net income has little impact on our analysis as we prefer to evaluate the company’s performance on a cash flow basis, which excludes noncash charges, namely, depreciation expense.
EARNINGS & GROWTH ANALYSIS
For 2020, Enterprise continues to expect capital spending of $2.5-$3.0 billion and a quarterly distribution of $0.4450 per share.
With respect to long-term growth, we note that EPD has a leading position across the natural gas and NGL value chain in some of the largest-producing basins in the U.S. It also has about $3.9 billion in growth projects that are expected to enter service over the next several years, and, despite the impact of the pandemic, will continue to invest in natural gas, NGL, and crude oil infrastructure to support shale play development. The growth in hydrocarbon production from shale basins and unconventional drilling has resulted in structural cost advantages for petrochemical production in the U.S. and has increased NGL demand from the petrochemical industry. This should boost earnings visibility and support growth in the distribution. EPD has the highest distributable cash flow coverage ratio in our MLP coverage universe.
FINANCIAL STRENGTH & DIVIDEND
Enterprise Products has eliminated the incentive distribution rights previously held by the general partner, and is transitioning the company to mainly fee-based businesses that are supported by long-term contracts. This allows the company to have one of the lowest costs of capital in its MLP peer group.
The increase reflected debt issuance to help fund acquisitions.
On March 18, 2020, EPD announced its 63rd straight quarterly distribution increase, to $0.4450 per unit. The annualized payout of $1.78 yields about 10.7%. Reflecting challenging market conditions, management plans to keep the distribution unchanged in the near term.
Enterprise Products initiated a $2.0 billion share repurchase program in January 2019. It repurchased 6.4 million common units in the open market in 1Q20 for approximately $140 million, but did not repurchase any units in 2Q20 due to market conditions. However, in 3Q20, it repurchased 2 million units for $34 million. Year-to-date in 2020, they have repurchased $174 million or 8.3 million units.
MANAGEMENT & RISKS
Jim Teague, formerly the company’s COO, became CEO on December 31, 2015, succeeding Michael Creel. We think that EPD management has performed well over the last several years through a combination of accretive acquisitions and internal growth. Its efforts have led to increased earnings and cash flow. We are also impressed that management purchases outside energy assets only after thorough due diligence.
Investment in pipelines also involves risks related to fires, explosions and environmental issues. All of the company’s pipelines are regulated by the Federal Energy Regulatory Commission (FERC). The normal tax risks of investing in MLPs apply to this investment. Unitholders are responsible for payment of taxes on their pro rata share of company earnings, whether or not any cash distribution is made. Unitholders have no control over the general partner or the election of officers of the general partner. In addition, investors’ holdings could be diluted by the issuance of additional partnership units. The controlling unitholder of the partnership could also reduce the price by disposing of a large number of units.
The company completed its IPO in July 1998.
Our multistage dividend discount model yields a fair value of $20 per share, which is our target price.