Source: Kinder Morgan
The worst oil crash in half a century has laid bare the painful truth that high-yields come with high risk and income investors that choose yield over quality do so at their peril. Take for example the case of two of America's largest pipeline blue chips, Kinder Morgan Inc. (KMI 1.73%), and Enterprise Products Partners (EPD 1.60%).
Over the past year Wall Street has punished both severely, but while Kinder Morgan's collapse was well earned, Enterprise Products Partners' is a classic case of a market overreaction.
Let's examine Enterprise Products Partners' full year 2015 earnings results to see just why this midstream MLP represents one of America's highest quality high-yield dividend growth stocks. More importantly, learn why Enterprise is so well positioned to not just protect its generous payout in a world of lower energy prices, but continue rewarding long-term investors with ongoing distribution growth for years to come.
Business model that's all about stability
The basis of the midstream MLP business model is a toll booth like river of cash flow ensured by long-term contracts. Enterprise Products Partners' contract mix takes this basic premise and improves upon it via many of its contracts guaranteeing a minimum operating margin for use of its highly diversified assets.
Specifically I'm referring to Enterprise's focus on several key types of energy pipeline including: natural gas, crude oil, petrochemicals and refined petroleum products, and natural gas liquids or NGLs.
Why is this so valuable to dividend investors? Because while low oil and gas prices may decrease oil and gas production, (so called "supply push" volumes), very low gas and NGL prices can provide volume protection because demand from oil and gas customers ("demand pull" volumes) can offset this. This provides Enterprise Products Partners' distributable cash flow or DCF -- which is what pays for the sustainable and steady distribution increases -- incredible stability despite oil prices collapsing 70% since their mid 2014 highs.
For instance, in 2015 Enterprise's DCF (excluding asset sales) increased 2.5%; quite impressive given the carnage of the current energy markets.
Payout profile that can withstand almost any storm
Source: Enterprise Products Partners investor presentation.
These images illustrate Enterprise's two largest competitive advantages, and why its such a superior choice to rivals such as Kinder Morgan.
Due to a lack of a general partner (which almost all other midstream MLPs have), Enterprise is able to retain a large amount of excess DCF. Further strengthening this ability is management's conservative approach to distribution increases.
Whereas other pipeline operators, such as Kinder Morgan prior to its 75% dividend cut, focused on growing their payout as quickly as possible at the expense of retaining almost no DCF, Enterprise Products emphasizes slower, but far steadier payout growth.
In fact in Q4 2015 the MLP announced its 46th consecutive quarterly payout increase. What's more, management even issued 2016 distribution growth guidance predicting 5.2% growth, creating a generous forward yield of 7.0%.
Large growth opportunities and most importantly...
Investors should never simply accept management guidance as gospel. Rather you should require evidence that 2016 will have some kind of growth catalyst that will result in DCF growth sufficient to sustainably achieve the MLP's payout growth target next year.
In this case Enterprises' DCF growth next year will come courtesy of $4.5 billion in new projects coming online.
Source: Enterprise Products Partners investor presentation.
Of course planned projects need to be funded and that is where another Enterprise Products Partners' strength lies; in its $4.4 billion in available liquidity as of the end of 2015.
...plenty of access to cheap capital to execute on it
With financial markets in a near panic over the threat of energy defaults Enterprise Products Partners' annual excess DCF of over $1 billion per year is a godsend that helps it to fund a significant portion of its growth internally. Not only does that result in a much lower leverage ratio than rivals such as Kinder Morgan, (which is partially why Enterprise has the highest credit rating in the industry at BBB+) but it also minimizes the need to raise equity funding by diluting current investors with a rising unit count.
That in turn helps keep the coverage ratio high and makes further steady payout growth much more likely to continue for many years to come.
Bottom line
The sad story of Kinder Morgan's dividend cut should serve as a cautionary tale that shows the importance of long-term investing principles. Specifically the dangers of focusing primarily for short-term yield and payout growth rather than long-term distribution security and steady growth.
With Enterprise Products Partners income investors have the opportunity to invest in one of the industry's best managed midstream MLPs; and at valuations that not only lock in a generous current yield but is also likely to result in market crushing total returns in the years ahead.
