Enterprise Products Partners: Enticing Dividend Yield of 7-8 %

No matter how much I like or say I like growth stocks, I’m still very much a value/dividend investor at heart. I do like the extra income and enjoy the regularity of it. Growth stocks are great but until I sell those stocks, I don’t see the money. Hence I still like a good portion of my portfolio to spin off income for me regularly. I can spend the dividend on things that I need, or I can reinvest the dividends thus enhancing the compounding effect.

I plan on reaching LeanFire status within the next 5 to 7 years so deriving dividends from my portfolio will be essential.

With diversification in mind, I decided to look outside Singapore for some cheap dividend stocks. I found Enterprise Products Partners (EPP), an American midstream natural gas and crude oil pipeline company with headquarters in Houston, Texas. 

Enterprise Products Partners’ Business

Enterprise Products Partners (EPD) provides midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, petrochemicals, and refined products. EPD is a fully integrated midstream energy company (see picture below).

From: Enterprise Investor Presentation

At 50 billion market cap, EPD is the third largest energy company in the USA (after ExxonMobil and Chevron; 9th largest in the world), with about 50,000 miles of natural gas, natural gas liquids (NGL), crude oil, refined products, and petrochemical pipelines. It also owns a number of storage facilities, processing plants, and export terminals.

EPD is a midstream company. What is a midstream company?

Well, how do oil and gas products go from deep in the ground into the hands of consumers? This is where EPD as a midstream company comes in.

There are basically 3 main oil sub-industries:

1. Upstream: exploration and extraction from the ground

2. Midstream: transportation and storage

3. Downstream: refining and marketing

EPD as a midstream company stores and transports oil and gas products, and its main asset is its huge network of pipelines.

EPD derives most of its profit from fees it charges exploration and production customers for its transportation and storage services. For the first 9 months of 2021, 82% of its profit comes from the fees its collects, 4% from commodity sales, and the rest from differential contributions such as propylene and octane enhancement marketing. EPD’s fee-based business is well protected from volatility in fuel pricing..

Results and Ratios

1. Total Revenue: From the data presented by EPD, its total revenue has been rising over the past few quarters, from $6922 million in 3rd quarter 2020 to $10831.30 million in 3rd quarter 2021.. Gross revenue for 3rd quarter 2021 records an impressive 56.47% increase from a year ago. EPD’s gross revenue for the twelve months ending September 30, 2021 was a 29.54% increase YoY.

2. Net Profit: Net profit for the quarter ending September 30, 2021 was $1.153B, a 9.61% increase YoY.

3. EPS Growth: UP8.33% YoY.  $0.52 (2021) vs $0.48 (2020).

4. Free Cash Flow: Free cash flow from 2018 to 2020 has kept to the $2 billion range. For the first 9 months in 2021, EPD has amassed $4.582 billion of free cash!

5. ROE: 15.14% in 3rd quarter 2021 vs average ROE 16.6% (for past quarters since March 2018) [my criteria: above 15%].

6. ROA: 5.99% in 3rd quarter 2021. EPD’s ROA has been in the 5% range and above since FY2012. [my criteria: above 5%].

7. Leverage Ratio: Debt to EBITDA is 3.2x [my criteria below 3x}

8. PB Value (MRQ): The book value of EPD is $11.44 per share. Based on today’s price (6 Jan) of $23.27, the current PB ration stands at 2.03. Back in March 2020, EPD’s PB value was 1.03. This was probably the best time to buy EPD based on PB value. Since then, EPD’s PB has risen to its current value at 2.03. EPD’s 5-year average PB ratio is 2.26, this means for years, EPD has not been trading below its NAV.

9. Fair Value: Based on DCF calculation (using conservative figures) however, I estimated EPD’s fair value to be $22.28. I bought EPD at $22.191 per share, slightly below my target price. Alphaspread.com estimated EPD’s fair value to be $25.86. So based on that and my purchase price, I’m looking at a 16.5% upside. Marketbeat published an analyst price target consensus of $27.67 for EPD, highlighting a 18.89% upside. SeekingAlpha sets the average target price at $28.23. My DCF estimation is fairly conservative, and I’m happy to have bought EPD at a price I was comfortable with.

Why did I buy Enterprise Products Partners?

Uninterrupted and Growing Distribution: If there is one thing to know about EPD, it is that it has never stopped paying dividends since its IPO in 1998. How did this happen? The reason lies in its business model: a great bulk of its profit comes from the fees it charges its customers. Most of EPD’s revenue are safe-guarded by long-term, fixed-fee contracts with minimum volume guarantees and annual rate escalators to counter inflation. Consequently, EPD’s distributable cash flow has risen consistently in spite of wild swings in the price of fuel.

One other thing to know about EPD is that it has grown its distribution over the past 23 years. 2020 was a very difficult year for companies in the energy sector and yet EPD was able to cover its distribution with distributable cash flow by 1.6 times! With EPD’s distribution well covered by free cash flow, there is plenty of room for trouble before a dividend cut becomes necessary. Just think about it. The dot-com bust in 2000 did not affect EPD’s distribution. Nor the great financial crisis from 2017 to 2019. Nor the 2020 Covid-19 pandemic.

From: Enterprise Investor Presentation Nov 2021

For the 12 months ended September 30, 2021, EPD’s dividend Payout Ratio was 51% (30% reserved for capital investment). EPD’s management is prudent in returning capital to investors.

EPD is offering a near-8% yield, coupled with share buybacks to boost shareholder value and share price. On top of that EPD is increasing cash distributions year after year for 23 years. Just yesterday (Jan 7), EPD declares $0.465 per share quarterly dividend, a 3.3% increase from the previous quarter dividend of $0.450. Sweet news indeed!

Based on my purchase prise $22.191 per share, I’m looking at 8.09% dividend yield. As a foreign investor, I’m subject to 30% withholding tax on dividends. So ultimately my dividend yield for EPD comes down to 5.663% which is still within my desired dividend yield range.

Conservative Financial Management: As mentioned earlier, EPD’s debt to EBITDA ratio stands at 3.2x, a little lower than the set target at 3.5x. EPD has successfully deleveraged its balance sheet and will not have to utilise significant amounts of cash towards reducing debts going forward. EPD’s lower leverage ratio reflects a financially responsible business. EPD also has $6.7 billion in additional liquidity to meet any needs.

Since 2018, EPD has been using internally generated cash flow and some debt to fund part of its expansion projects. It no long issues equity to meet any expansion needs. EPD has also been conservative with the use of leverage (not that it does not utilise any credit facilities). Nevertheless, as of 3rd quarter 2021, 100% of cash flow from operations (0% debt) is used to finance capital investments. Such an approach helps EPD to reduce its financing risk and lower its cost of capital.

Standard & Poor (and Fitch) gives EPD a BBB+ credit rating, the highest in the midstream energy space. Such a rating helps EPD maintain dependable, low-cost access to debt markets to fund its growth, should it need to do so.

What does EPD’s well-managed debt portfolio look like? 54% of the bonds issued are long-term, of 30 years and above. Another 30% of the debt is attributable to 10-year bonds. 83.6% of EPD’s notes will come due further into the future, past the 10-year mark, as EPD has taken advantage of the low interest rate environment to borrow money for longer terms. The average interest rate EPD has to pay is a reasonable 4.4% (3rd Quarter 2021). 99.2% of its debts are fixed rate based, thus minimising volatility in its interest payments.

From: Enterprise Investor Presentation Nov 2021

Overall, EPD’s conservative finances (strong balance sheet and well-managed debt portfolio) make it resistant to challenges and help it weather through industry headwinds. EPD has a proven track record of allocating capital efficiently and employ debt prudently.

Protected from Volatility in Gas Price Movements: It’s common knowledge that natural gas and crude oil prices fluctuate wildly from day to day. Take natural gas as an example. It has gone from a high of $6.463/MMBtu on October 5 2021 to 3.805/MMBtu on January 6 2022. EPD’s business is not that exposed to oil and gas price movements.

Why?

Simply because, as mentioned earlier, EPD’s business is contract-based: Customers pay EPD based on agreed-upon prices. This means EPD’s revenue, and consequently its cash flow is protected by long-term, fixed-fee contracts. These contracts come with guarantees of minimum volume and annual rate escalators to offset inflation.

In short, EPD gets paid fees based on how much it transports for its customers. EPD does not benefit from increases in oil and gas prices , nor suffer from decreases. EPD’s business model is both simple and stable, and this very nature of its business has allowed it to successfully navigate booms and busts in the energy industry. 

Insider Ownership. EPD’s management has skin in the game. If the management owns large portions of EPD shares as they have confidence in the business, why shouldn’t anyone else? The management and the Duncan family (founding family) owns approximately 32% of the outstanding units of Enterprise Products Partners. The insider buying in 2020 and 2021 is indicative of the management’s confidence in the company business and faith in the company’s future, and of the management’s satisfaction that the stock was undervalued. The high insider ownership of the company stocks shows a management whose interests are aligned with the regular unit holders.

Growth Plans: Over the years EPD has continued to invest and grow. To date, EPD has $2.9 billion of major capital projects still under construction. By the end of the previous quarter (Q2 2021), EPD has already completed roughly $480 million in organic growth projects.

Let’s look at growth in one segment of EPD’s business, namely, the Natural Gas Liquid segment. As explained in the 3rd quarter 2021 report, the US Energy Information Administration is projecting an increase in the global use of energy by some 50% by 2050. This increase in the use of energy globally is spurred by economic growth in non-OECD regions and a growing population (10 billion by 2057). An increase in population means an increase in energy use, thus boosting EPD’s business (not rocket science, right?).

The USA is the world’s largest consumer (70% of global demand) and exporter of LPG. Of the 1166 MPBD of LPG exported in 2021, EPD accounted for 44% of it (513 MPBD)! EPD is the world’s largest exporter of LPG and business growth is assured in the future.

Threats from Clean Energy?

Is EPD facing headwinds from the rise of clean energy? Certainly.

Even so, I am under no illusion that the world will cease using fossil fuel altogether in the next 10 to 20 years, or even the next 50 years. Does anyone?

Yes, social and political pressures might be growing against companies in the energy sector, but truth be told, the world still needs oil, natural gas, and the products into which they are made. Don’t get me wrong. I do agree with clean and green and renewable energy. What I saying is the world still needs fossil fuel even when clean and renewable energy such as solar and wind energy are available.

Co-CEO James Teague said it best during an investor conference call: Reading the news, some may think the sun is setting on oil and gas … Obviously, policy proposals from this new administration have been supportive of renewables. The cleaner energy future does not mean a world without fossil fuels. The reality is nothing could be further from the truth.”*

Teague acknowledged that there are still 3 billion people who are living in energy poverty who can be served by US energy companies. As Teague put it, “while discussion of the global energy transition often implies shifting away from traditional hydrocarbons, Enterprise still believes an “all-of-the-above approach” will be required to meet the world’s growing energy needs.”

That said, will the likes of G. Thunberg create hostility towards pipelines? There’s a possibility. But whatever the push towards cleaner energy alternatives may be, the fuels that flow through EPD’s pipelines will remain important for years to come (my honest opinion, of course). The rise in global population, especially middle class population growth, will lead to a need for more energy of all kinds.

One major risk I can see is in the area of government regulations. In June last year, President Biden denied the approval TC Energy needed to construct a 1200 mile crude oil pipeline. Will EPD face the same fate one day on any one of its projects? This is a strong risk factor for EPD. However, EPD has navigated the current regulatory environment well thus far. Still this is a risk that I must pay attention to.

Conclusion

I entered a position in EPD because I wanted a value/dividend play in the energy sector. My position is that as long as the world needs fossil fuels, then EPD’s business and assets will continue to be relevant, its revenue will hold up, and its cash flow will remain secure.

The diagram below illustrates very clearly just how important and irreplaceable fossil fuels are. EPD is earning money throughout almost every aspect of the midstream sector. There is a lot to like in Enterprise Products Partners.

From: Enterprise Investor Presentation Nov 2021

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Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.

The Last Quarter of 2021

Before I knew it 2021 was over and we are now in the first week of 2022.

2021 wasn’t as turbulent a year as 2020, as hope and excitement flourished with the worldwide distribution of vaccines.  Even with several mutations of the Covid-19 virus, the pandemic wasn’t quite as feared in 2021 as in 2020.  

As 2021 entered the last quarter, global economic recovery remained in force.  And this was in spite of the ongoing impact of supply chain delays, the uncertainty of FED tapering, and the rising fear of higher inflation in many countries.

Against such a backdrop, I continued my investing ventures in the last quarter of 2021:

27 October: Ping An @HKD60.00

1 November: Meta (Facebook) @USD331.98

3 November: Enterprise Products Partners @USD22.10 (more about this company in the next post)om,

17 November: Mapletree Industrial Trust @SGD2.66

17 November: Keppel DC Reit @SGD2.34

During this period in time, I also liquidated my entire holdings in SYFE and MoneyOwl, and poured some money into cryptocurrencies (ranked in terms of holding size):

1. Ethereum (23.27%)

2. Bitcoin (14.04%)

3. Matic Network (11.87%)

4. Curve Dao Token (8.66%)

5. Decentraland (8.40%)

6. Sandbox (7.67%)

7. Litecoin (6.88%)

8. Kyber Network (4.55%)

9. Filecoin (3.44%)

10. Dogecoin (2.49%)

11. Aave (2.49%)

12. Uniswap (2.31%)

13. Chainlink (2.06%)

14. Compound Coin (1.88%)

Cryptocurrency has made quite a number of investors filthy rich. It is common knowledge that crypto is a high-risk asset class (think market volatility, potential future regulations, cybersecurity concerns etc). Even so I believe there is a place for cryptocurrency in my portfolio.

Love it or hate it, crypto is here to stay. According to CoinGecko, the market capitalisation for all cryptocurrencies has gone beyond $2.5 trillion (up from 750 billion in 2020). Hedge funds and companies such as Tesla and Microstrategy have invested in crypto as they see opportunities to earn serious gains. I may be late to the party but I certainly do not want to miss out on this attractive asset class, as much as my risk appetite would allow, of course.

For now I intend crypto to occupy no more than 5% of my total portfolio. I still have quite a bit of room to expand my crypto portfolio. I intend to continue putting my money into crypto by focusing on the top 5-6 positions.

As I load up on cryptos and growth stocks, I have not paid much attention to accumulating more dividend stocks. I guess I am still trying to find the right balance in the growth and dividend spectrum for what best fits my risk appetite. My growth stock portfolio is doing terribly. I am staring at a paper loss of SGD 5966.60. On the other hand, my dividend stock portfolio is doing much better, bring me 19.95% overall growth in profit and dividends.

As the year closed, I was sitting on a little more cash than I did at the beginning of 2021, thanks to 2 side hustles. I hope to have some extra cash on hand to take advantage of any market pullback that might happen in 2022.

If I had to appraise myself in my role as an investor in 2021, I would say I was a distracted one. Too many things happened in 2021: disruptions at work, moving into a new property, preparing kiddos for examinations etc. Thankfully most of the dust have very much settled. Work seems to be normalising now, we are enjoying the new place, and kid #2 has joined kid #1 in Bishan-Braddell Secondary (yay!).

As I stand at the threshold of 2022, I hope the pandemic will finally end and the world returns to how it was before March 2020. May there also be many opportunities to strike it big with investment decisions and actions.

The Great China Sale: Alibaba & Tencent

In the past three months, I did a number of stock purchases in a bid to grow my existing portfolio.  Arranged chronologically, my stock purchases from July to the present are as follows:

28 July: Alibaba @HKD181

29 July: Tencent @HKD488.40

31 August: SGX @SGD9.972

2 September: Alibaba @HKD169.7

16 September: Alibaba @HKD153.6

4 October: Keppel DC @SGD2.42

11 October: Lion-OCBC HS Tech @SGD1.079

A significant portion of my money went into Chinese stocks. I went into Chinese stocks in spite of the China market meltdown. A lot of the fear, though very justified, has been dramatised and played up to bring about the market meltdown, in my opinion.  I entered the China market to enlarge the China portion of my portfolio when many are fleeing or have fled.

Since almost a year ago, Alibaba stock has been on a sharp downtrend.  At today’s price HKD168.40 (Oct 11), the stock has fallen some 45% from its 52 week peak (52 week high: HKD309.40; 52 week low: HKD132) and it is definitely undervalued.  I estimated Alibaba’s intrinsic value to fall in a range between HKD280 to HKD350.  

Alibaba had been under fire since Ant Financial’s IPO was canceled by the Chinese authority last year.  Several months from that failed IPO launch, sometime in April, Alibaba was issued a USD2.80 billion fine in a landmark antitrust cases.  Alibaba stock also got cut down further in recent months with the rest of the tech sector under the Big Tech crackdown.

While some has given up on Alibaba, I still think that all hope is not lost on Alibaba.  Sure, it is not the shiny star it once was, but its business is still doing just fine.  Even Charlie Munger seemed to think so, having doubled his stake in Alibaba in the third quarter this year.

It still makes sense to invest in Alibaba:

1. The group owns multiple ecommerce sites and controls over 50% of China’s e-commerce market.  It is undoubtably still the “Amazon of China”.  While Alibaba’s main income comes from its e-commerce business, it also has considerable influence in other segments such as cloud computing, digital media and entertainment, and innovation initiative and venture investments.

2. Alibaba boasts of having some 1.18 billion active consumers on its entire ecosystem, 912 million consumers in China and 265 million consumers overseas served by Lazada, AliExpress, Trendyol and Daraz.  

3. In fiscal year ending March 31, 2021, gross market value transacted on Alibaba’s e-commerce market places in China alone reached approximately 7.49 trillion yuan (an increase of 13.74% from 6.59 trillion yuan a year ago).

4. Alibaba still owns roughly 33% stake in Ant Group, which owns China’s largest digital payment platform Alipay (processes more than half of China’s third-party payments).  Ant group is undergoing government-mandated restructuring.  China’s central bank governor Yi Gang raised the possibility on Tuesday that Ant Group could be allowed to pursue an IPO once it fully satisfies China’s new fin-tech regulations.

5. Alibaba’s financials still remain stellar.  In its 2Q report, Alibaba’s posted USD32 billion of revenue, a 34% increase from 2020. It still sits on a huge pile of cash, some USD73 billion in cash, equivalent and short-term investments on its balance sheet as of June 30, 2021.  And this signifies Alibaba is financial sound and has the wherewithal to expand its business or acquire any emerging competitors. 

6. The share price of Alibaba has literally fallen into an abyss in recent months from its 52-week peak at HKD309.40. As the share price fell, so did the PE.  Its current PE is about 20, a far cry from its elevated PE of 42.85 about a year ago.  Given its dominance in China’s e-commerce space, and its potential for future growth, Alibaba at its current price is literally a steal.  I only wish I have bought Alibaba at HKD135++ just a week ago.

Buying Alibaba, or any of the Chinese tech stocks for the matter, comes with one huge risk … regulatory risk.  This time round the Party’s hand has come down very hard on these big tech companies, wiping off billions of market value.  

It looks like the regulatory storm has kind of abated as these giant tech firms obediently subject themselves to the new regulations.  The questions, though, are: (1) when will the current legislative onslaught end? (2) will there be more rounds of crackdown at some point in the future?  One thing for sure about regulatory risks from China is that they are highly unpredictable.

As of now, regulatory uncertainty still remains, but I think it is okay to nibble a little here and there to take advantage of price weakness.  China’s top-down governance model has always been interventionist, and does not suffer the rise and dominance of any monopolistic company within its borders.  Even so, Alibaba’s strong business and financial fundamentals, coupled with its growth potential and relatively inexpensive valuation makes it an attractive investment.

As of January 1, 2020, Alibaba was the largest China company by market cap.  After the regulatory blitz, Alibaba slipped to number 2 position.  Tencent is now the largest company in China by market cap.

Tencent has been losing its shine since February this year.  Tencent suffered the same fate as Alibaba when the country’s top market watchdog began a probe into its alleged anti-competition practices in its music-streaming business.  Tencent was also investigated and duly fined for not properly reporting past acquisitions and investment for antitrust reviews.

In early August, a mainland newspaper published a report calling online gaming “spiritual opium,” and singled out Tencent for harming China’s teenagers by making them addicted to the games offered by Tencent.  In a matter of two weeks from the newspaper report, Tencent share price dropped to its lowest in 15 months, to a new low of HKD421.20.  

I began to take notice of Tencent when its share price go south slowly beginning in February.  I didn’t take action until late July.  On hindsight, I might have acted too early, missing out on lower stock prices for Tencent in August.  

The crackdown has made Tencent an attractive investment to me:

1. Tencent is a huge tech titan and makes money from its core businesses in value added services (games and social networks), online advertising, and FinTech and business services (cloud-computing).  Tencent’s market cap is USD602.1 billion, making it the 7th largest company by market cap in the world.

2. Tencent owns 51% of the market share in online gaming in China.  NetEase, the second largest online game provider in China only has 18 percent of the market share.  To help curb teen addiction to their games, Tencent has a set-up that locks out teens after 1 hour of playing on school nights and 2 hours during holidays.  Tencent said that 2.6 per cent of its revenue originates from players under the age of 16 and 0.3 per cent from under 12s. So this cracking down on teens’ activity on mobile game platforms hardly puts a dent in Tencent’s total gaming revenue.  In Q2 2021, mobile games accounted for 30% of Tencent’s overall revenues of $6.3 billion, a rise of 13 per cent yoy.  

3. Tencent’s advertising and FinTech+business services segments are also firing on all cylinders.  Its advertising business revenue (ads on WeChat and QQ, for example) rose 23% yoy; its Fin-tech+business services revenue grew 40% yoy.  Tencent offers several of its software tools for free: Tencent Meeting, WeCom, Tencent Docs etc.  These software tools have great commercial value and the FinTech+business services will get a further boost should these tools be monetised.

4. Tencent is the “Berkshire Hathaway of China”.  It has taken significant minority stakes in winning companies such as Tesla (4%), Spotify (4%), Snap (12%), and SEA (25%).  Just its stakes in SEA, Snap and Tesla alone make up 17% of Tencent’s total market cap.  Tencent invests to expand its empire and grow its wealth.  Tencent’s net debt position totalled RMB21 billion.  This is a small sum compared to the fair value of Tencent’s stakes in these investee companies which totalled RMB1446 billion.

5. The share price of Tencent is pretty fair-valued now, having fallen about 36% from its 52-week high of HKD775.20.  As long as Tencent stays below HKD500, I think it is a fair bargain, especially given its dominant business and prospect for growth.

6. Since announcing its Q2 results in August, Tencent has been buying back its own shares, about 2.2 million shares, at an average price of HKD464 per share.  This share repurchase program indicates Tencent’s confidence in its business outlook and long-term strategy, government regulatory measures notwithstanding.

Just like Alibaba, Tencent faces regulatory risks as well. 

Regulatory clampdowns, be it an antitrust crackdown, data security overhaul, or just a check on capitalist excesses, are nothing new in China.  The Chinese government does not intend to damage these tech giants.  It only wants to regulate them, and truly there is a world of difference between regulating and destroying.

Back in 2018, for instance, the Chinese authorities took steps to limit the number of online games and reduce screen time.  Why?  Mr Xi thought that too much game playing was damaging children’s eyesight.  In a day, Tencent shares came tumbling on the Hong Kong Exchange.  Damage was only temporary, and in no time Tencent’s share price rose again.  

The tougher regulatory environment is here to stay (I might even say, it has always been here all along) and investors will have to look beyond this and refocus on the business potential of Tencent.

Conclusion

Because of the way China is and operates, there will always be uncertainty for investors.  Hence, Chinese stocks will not form a large portion of my portfolio … maybe subject a 20-30% allocation limit.  

The Chinese stock market has been on sale for a while now and the opportunity to pick up some good buys are here.  Alibaba and Tencent stocks present themselves as excellent long-term opportunity today.

I believe these two bellwethers will survive the regulatory storm.

Everyone has the brainpower to make money in stocks. Not everyone has the stomach.

Peter Lynch

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Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.