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).
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.
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.
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.
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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.
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