Enterprise Products Partners L.P. (EPD) is the biggest midstream player in oil and gas. Think pipelines, storage, gathering and processing, export terminals, petrochemical plants, and other extremely valuable and hardly replaceable assets over vast US territories. For many, it is the ultimate investment due to its unique features. Although some of them are well-known, I will start by commenting on them. After that, we will proceed to valuation and suggest a strategy for investing in EPD.
High and growing yield
It is now forward-looking ~6.7% and the distribution keeps increasing by 2-2.5% every 6 months. Some investors, retirees in particular, take an extreme position of not being concerned about the stock (or unit, in EPD’s case) price as long as the yield is high, growing, and sustainable. Almost all EPD articles emphasize high yield without explaining what “high” means. Not so long ago, EPD’s yield was 8%. Do you still think 6.7% is high? How about 6%? Investigating EPD’s threshold yield will be an important part of this article.
Tax-advantaged distributions
EPD benefits from its status as an MLP, which provides tax advantages to U.S. investors (just in case - do not hold EPD in IRA accounts!). Simplified, investors face minimal or no taxes on distributions for the first 7 years or so, thanks to a depreciation shield that offsets the partnership's earnings. EPD’s maintenance CapEx is much lower than its depreciation expenses, making its accrual earnings significantly lower than its cash flows.
Once the depreciation shield is exhausted, distributions are taxed as ordinary income. Additionally, when selling EPD units, investors are subject to "depreciation recapture," with a part of the capital gains taxed as ordinary income.
This latter aspect is a strong EPD advantage for me. MLP investors may become forced sellers if their MLP is acquired for cash. EPD’s large size and substantial insider ownership almost eliminate this risk.
Strong distribution coverage and low leverage
EPD’s distribution coverage is typically slightly below 2, at 1.9 in 2023. I don’t focus on the exact figure as long as it remains sufficiently high, given that excess cash flow is typically allocated to capital projects. In other words, EPD is not hoarding cash but rather reinvesting it, which supports the sustainability of future distributions.
Low leverage is one of the EPD’s best features. EPD’s debt is rated A- which makes it safer than its peers and provides a desirable optionality to the company’s strategy.
Insider Ownership
EPD has high insider ownership of ~32% mostly in the form of the Duncan Family Trust (Dan Duncan was the EPD co-founder and main shareholder who passed away in 2010) evenly split between four of Duncan’s children. One of them (Ms. Randa Duncan Williams) has been actively involved in running EPD - she was the CEO during 1994-2001 and is currently its Chairman.
The existence of a dominant and knowledgeable unitholder is generally beneficial for retail investors: you can be assured that the best management is hired and prevented from self-dealing. You can also be certain that the company will be run in the interest of long-term holders with positive consequences such as a solid balance sheet and certain conservatism.
However, the alignment between the Trust and retail investors is not perfect. A billionaire not actively involved in the business (3 siblings have not been involved) is more concerned with the preservation of her capital, steady income, and gradual growth. Besides, this billionaire is more constrained in the movement of her massive capital locked in the Trust. On the contrary, many retail investors still badly want to become materially richer and can quickly move their capital. This is where the alignment ends except for those who are happy with just receiving their gradually growing distributions regardless of anything else.
Most of the above is summarized in one of EPD’s recent slides.
Natural gas versus oil
EPD benefits from much higher exposure to natural gas vs. oil as the former has gained from several unrelated factors and developments, with some of them very recent.
Oil is more susceptible to environmental scrutiny compared to natural gas.
Russia has lost most of its natural gas markets in Europe due to the war in Ukraine and related events. The U.S. is stepping in to fill this gap with increased LNG shipments. The new U.S. administration will likely approve more LNG terminals, further driving natural gas demand. More natural gas/NGL infrastructure will be required which will further boost EPD growth.
Natural gas is well-positioned to play a significant role in meeting the energy needs of data centers. It offers greater reliability and requires less physical space compared to solar and wind. Furthermore, it is more cost-effective than solar or wind combined with battery storage and can be deployed much faster than nuclear energy.
One barrel of oil is equivalent to ~6 million BTUs (MMBTUs) of natural gas in energy content. Historically, these 6 MMBTUs of natural gas have been much cheaper than a barrel of oil, primarily because oil is easier to handle, store, and transport. This price gap could narrow as developing LNG infrastructure makes natural gas more accessible and easier to ship globally, reducing logistical disadvantages and increasing its competitiveness with oil.