For investors interested in high-yielding dividend paying stocks, they've probably come across Enterprise Products Partners (EPD -0.39%). The company is structured as a master limited partnership (MLP), which is not taxed at the corporate level and thus passes through much of its income to investors in the form of distributions.
Distributions are similar to dividends but are more favorably taxed. Typically, a large percentage of distributions are treated as a return of capital. This portion is tax deferred, reducing an investor's cost basis in the stock, and is not taxed until the investment is sold. This also means that it is essentially taxed later at the lower capital gains tax rate and not as ordinary income. This does include some extra paperwork come tax time, but it is a nice benefit.
For a business standpoint, Enterprise is an energy midstream company that owns a network of pipeline and other midstream assets. It transports, stores, and processes an array of hydrocarbons, including natural gas, natural gas liquids (NGLs), crude oil, and refined products.
Let's look at three reasons why I think the stock is a buy right now.
Robust and growing distribution
Enterprise currently sports an attractive forward yield of 6.3%. Importantly, its distribution is well covered by its distributable cash flow (DCF), which is operating cash flow minus maintenance capex (capital expenditures). In addition, the company has a solid balance sheet with low leverage for the industry.
Enterprise's distribution coverage ratio came in at a robust 1.7 times last quarter, which means that it produced DCF that was 70% higher than its distribution payouts. Meanwhile, it ended the quarter with leverage of 3 times. Midstream companies typically carry leverage from 3x to 4.5x due to the strong cash-flow nature of the industry, while Enterprise has a conservative target range between 2.75x and 3.25x. Note that Enterprise defines leverage as its net debt adjusted for equity credit in junior subordinated notes (hybrids) divided by adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).
Meanwhile, Enterprise has been one of the most consistent midstream companies over the years. This is evident by it raising its distribution for 26 straight years through various economic and energy cycles. The company's business is backed largely by long-term, fee-based contracts with price inflation escalators, giving it strong visibility. It said that last quarter, 88% of its natural gas contracts had a fee-based component.
I would expect Enterprise to continue to steadily increase its distributions in the years ahead.
Image source: Getty Images.
Moving to growth mode
In addition to its consistently increasing distribution, Enterprise is also moving into more of growth phase, in part due to the opportunities it is seeing in NGL exports and power demand coming from AI.
The company slowed its growth capex spending following the COVID-19 pandemic, taking it from $3 billion in 2020 down to $1.8 billion in 2021 and $1.6 billion in 2022. However, it increased it back up to $2.8 billion in 2023 and now has plans to spend $3.5 billion to $3.75 billion in 2024, and $3.5 billion to $4 billion in 2025.
In the recent past, Enterprise has been getting about a 13% average return on its projects once they have fully ramped up. This means that if it spends $3.5 billion to $4 billion in growth capex, it should help boost EBITDA by $450 million to $520 million a year once projects are fully ramped. With the company projected to generate $9.85 billon in EBITDA in 2024 according to analyst estimates, that's solid growth.
Enterprise currently has $6.9 billion in growth projects under construction in its backlog. Meanwhile, it has said that the power demand coming from AI is one of the best signals for increasing natural gas demand that it has seen, and that it is one of the few companies with the pipeline and storage assets to really capitalize on this opportunity. It noted that it is particularly well positioned in the Dallas-Fort Worth and San Antonio areas, which are becoming data center hot spots.
Natural gas demand in the U.S. is projected to see solid growth in the coming years, which will be beneficial to a company like Enterprise. Natural gas producer Antero recently projected that U.S. natural gas demand could double by 2030 driven by AI, exports to Mexico, and LNG (liquefied natural gas) exports.
Attractive valuation
On top of its solid, steady distribution growth and the growth opportunities in front of it, Enterprise trades at an attractive valuation from a historical perspective. The most common way to value midstream companies is using an enterprise-value-(EV)-to-EBITDA multiple, which takes into account its debt while removing the noncash costs associated with depreciation, since these costs have already been captured in its debt. On that basis, Enterprise trades at an EV/EBITDA multiple of 10 times 2024 estimates.
EPD EV to EBITDA (Forward) data by YCharts
Between 2011 to 2016, midstream MLPs traded at an average EV/EBITDA of 13.7 times, while Enterprise has generally traded at a premium given its consistent nature. With the stock trading at an attractive valuation and moving into growth mode, now looks like a great time to buy the stock.
