Investors flock to master limited partnerships (MLPs) as an asset class because of the income generated by these stocks. MLPs pay very high dividends – technically called distributions – because of their operating structure. MLPs enjoy a favorable tax classification and, in return, pass along the bulk of their cash flow to investors. This results in consistently high yields throughout the MLP asset class.
However, these are uncertain times for oil and gas MLPs. Due to the collapse in commodity prices over the past two years, many MLPs had to cut or suspend their distributions entirely to preserve cash flow. This means investors need to be highly selective when it comes to MLPs, and focus on the best companies with the strongest management teams and highest-quality assets.
Enterprise Products Partners (EPD ) is one of the best stocks of all the MLPs. It has achieved a long record of uninterrupted distribution payments, even with the price of oil falling from $100 to the current level of $50. In fact, Enterprise Products has actually raised its distribution for 48 quarters in a row. Most recently, the company raised its distribution by 5% compared to the same distribution one year ago. The new quarterly payout will be $0.40 per unit, or $1.60 per unit on an annual basis.
Toll Road Business Model Fuels Distributions
The major advantage for Enterprise Products relative to other oil and gas firms is that it operates in the midstream spectrum of the energy sector. These are companies that own and operate oil and gas pipelines and terminals. Enterprise Products’ assets include approximately 49,000 miles of pipelines. It has storage capacity for 250 million barrels of natural gas liquids, crude oil, refined products and petrochemicals, as well as capacity for 14 billion cubic feet of natural gas.
These assets operate very similarly to toll roads, in the sense that Enterprise Products collects fees based on volumes of materials transported and stored throughout its asset network. Because the company operates “take-or-pay” contracts, it is not as reliant on the price of the underlying commodity as other energy companies. For example, companies in the upstream segment of oil and gas exploration and production are entirely reliant on commodity prices.
As a result, Enterprise Products’ cash flow has held up relatively well, even in a very difficult climate for the energy sector. Last year, Enterprise Products generated $4 billion of distributable cash flow – a non-GAAP metric often used by MLPs instead of traditional earnings per share, which describes how much cash an MLP generates above its capital expenditures. This is cash flow that can be used to pay down debt or issue distributions to investors. Last year, the company covered its distribution with distributable cash flow by 1.3 times in 2015. This indicates Enterprise Products generated 30% more distributable cash flow than it needed to pay distributions last year, and leaves the company enough room to continue raising distributions. A major reason for this is that the company has significantly cut spending to be conservative with its capital management priorities. Last year, Enterprise Products reduced total capital spending by 21%.
Because of its fee-based model, the company is already returning to growth, even though commodity prices remain depressed. First-quarter operating profit and distributable cash flow increased 2% each, year over year. It once again generated a distributable cash flow coverage ratio of 1.3 in the first quarter. The best-performing segment for the company last quarter was the natural gas liquids pipelines and services business, which grew operating profit by 13% year over year. This growth was due to growth in export volumes. Enterprise Products retained $229 million of excess cash flow last quarter, which it will use to reduce debt and fund organic growth expenditures without the need to access the equity market for external capital.
The 5% year-over-year distribution increase is Enterprise Products’ 48th consecutive quarterly increase. The company has raised its distribution 57 times since its 1998 initial public offering. Enterprise Products has generated significant growth in earnings before interest, taxes, depreciation and amortization (EBITDA) over the past five years, along with satisfactory distribution coverage.
Going forward, investors should expect continued steady growth in cash flow and distributions for many years. Enterprise Products has a large backlog of future growth opportunities, which will steadily increase cash flow. The company successfully completed $2.7 billion of organic growth projects last year, which will add to future growth. This year, there are four more major-growth projects in the pipeline.
The Bottom Line
The new distribution rate will be $1.60 per unit on an annualized basis. This amounts to a 5.5% current yield, which is more than double the average dividend yield in the S&P 500. Its extremely high yield – combined with regular growth in the distribution – is why Enterprise Products is such an attractive stock for income investors.
