The energy sector has been one of the market’s worst-performing areas in the past several years. The combination of a global supply glut in conjunction with weak demand due to the coronavirus pandemic, has sent oil and gas prices tumbling. In turn, this has been an enormous headwind for the energy sector, which has led to collapsing share prices and dividend cuts across the industry, even for well-established giants like Royal Dutch Shell (LON:RDSa) and BP (LON:BP) (NYSE:BP).
Investors looking for value and safe income need to be selective when it comes to energy stocks. One pocket of value and relative safety within the broader energy industry is midstream oil and gas stocks. These are companies that operate storage and transportation assets. While no energy stocks are completely immune from falling commodity prices, high-quality midstream Master Limited Partnerships like Enterprise Products Partners (NYSE:EPD) continue to maintain their hefty distributions, even in a highly challenging environment.
With a current yield over 10%, and more importantly, a safe and fully covered distribution, Enterprise Products is one of our top-ranked MLPs right now.
Toll Road Business Model Fuels Steady Cash Flow
Enterprise Products Partners is an oil and gas storage and transportation company. It is a midstream company, meaning it owns and operates pipelines, terminals, and other related assets. In all, Enterprise Products has very high-quality assets including 50,000 miles of natural gas, natural gas liquids, crude oil, and refined products pipelines.
It also has storage capacity of 260 million barrels ofNGL, petrochemical, refined products and crude oil, plus 14 billion cubic feet of natural gas storage capacity. Furthermore, Enterprise Products owns 22 natural gas processing facilities, 24 fractionators, 11 condensate distribution facilities, and 19 deep-water docks.
The operating advantage for high-quality midstream companies like Enterprise Products is that they generate a steady stream of cash flow, without a high level of exposure to underlying commodity prices. Enterprise Products makes money based on the volumes of materials stored and transported through its system. In this way, the company operates similarly to a toll road.
Instead of relying heavily on high commodity prices, as is the case with the upstream exploration and production companies, the more important factor for Enterprise Products is demand. And thanks to the company’s high-quality network of assets, demand has remained intact over the course of 2020, even with the coronavirus pandemic taking down the broader economy.
Cost Cuts, New Projects To Pump Out Growth
In the second quarter, Enterprise Products reported a relatively mild 6% decline in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) and an 8% decline in distributable cash flow. Over the first half of 2020, adjusted EBITDA declined 3%, while distributable cash flow fell 7% compared with the first six months of 2019. This resilience in a very difficult environment has allowed the company to maintain its hefty distributions, even while oil and gas prices have declined precipitously.
The company expects to return to growth sooner rather than later, thanks to a mix of capital expenditure reductions and new growth projects coming on-line. In 2021 and 2022, Enterprise Products sees growth capital expenditures of $1.6 billion and $900 million, respectively, compared with $2.8 billion expected to be spent in 2020. This capital discipline will help the company preserve its strong balance sheet and allow it to maintain its high distributions in 2020 and beyond.
Over the long-term, continued growth is likely due to the company’s slate of new projects. For example, Enterprise Products recently placed the 10th fractionator into service at Mont Belvieu, with an 11th expected to be placed into service in the third quarter.Exports are also a key growth catalyst. Demand for liquefied petroleum gas and liquefied natural gas, or LPG and LNG respectively, is growing at a high rate globally, and especially in the emerging markets.
High-Quality Business Model Pays Dividends
Not only does Enterprise Products Partners possess best-in-class assets, it also has an extremely high-quality balance sheet in relation to most MLPs. In terms of safety, Enterprise Products Partners is one of the strongest midstream MLPs. It has credit ratings of BBB+ from Standard & Poor’s and Baa1 from Moody’s, which are higher ratings than most MLPs. It also had a high distribution coverage ratio of 1.6x in the 2020 first half, meaning the company generated approximately 60% more distributable cash flow than it needed for distributions over the first half of the year.
The company also ended the most recent quarter with a leverage ratio (defined as net-debt-to-trailing 12-month adjusted EBITDA) of 3.4x, which is lower than most MLPs and is below the company’s own target leverage ratio of 3.5x.
Another attractive aspect of Enterprise Products is that it is a recession-resistant company. Enterprise Products’ high-quality assets generate strong cash flow, even in recessions. As a result, Enterprise Products has been able to raise its distribution to unitholders for 21 consecutive years. Therefore, it has an established track record of delivering steady distributions and reliable increases on a regular basis, even in recessions.
Investors need to tread carefully when it comes to energy stocks. Investing in oil and gas stocks has been a treacherous endeavor the past several years, as the entire industry struggles against low commodity prices and weak global demand. But not all energy stocks should be avoided; investors simply must be more selective and make sure to choose the best operators with the strongest balance sheets.
Enterprise Products is just such a company. It has an excellent network of high-quality assets which generate strong cash flow, regardless of the broader economic climate. The company has a long track record of delivering consistent distributions, a manageable level of debt, and a positive future growth outlook. With a current yield above 10%, we view Enterprise Products as a buy for income investors.