EnLink Midstream Earnings: 3 Things All Dividend Investors Need to Know

Source: EnLink Midstream Partners

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The recent oil crash, which has hammered midstream MLPs such as EnLink Midstream Partners (NYSE: ENLK) and its general partner EnLink Midstream LLC (ENLC 1.19%), is a great opportunity for buying high-quality income investments at undervalued prices that could result in market thumping outperformance for years to come.

ENLK data by YCharts

Of course while the severe beating that MLPs such as EnLink have taken over the last year might potentially represent a great buying opportunity, it could just as well be a warning to avoid EnLink Midstream due to major problems with its underlying business model.

To help you learn how to spot the difference lets look at EnLink Midstream's full 2015 earnings results with a focus on the three most important factors income investors need to pay attention to when deciding whether or not to invest in a midstream MLP.

What midstream MLP earnings metrics matter most

Sources: earnings release, Yahoo Finance

Though midstream MLPs report earnings per unit because this is what Wall Street analysts focus on, its not actually of much importance to investors. That's because the tax structure of MLPs as well as capital intensive nature of the industry results in non-cash charges causing massive earnings volatility that represents neither an MLP's cash flow generating abilities or how much it can sustainably afford to pay out to investors.

Thus Adjusted EBITDA and distributable cash flow are the two key metrics to focus on and as you can see EnLink Midstream had a fantastic 2015, with phenomenal growth in both. This allowed moderate payout growth, however note how the distribution coverage ratio for 2015 still came in just above the 1.0 long-term sustainability cut off, despite massive increases in cash flow.

EnLink's growth was mostly fueled by a combination of $883 million in acquisitions, both drop-downs from its sponsor, Devon Energy (NYSE: DVN), as well as from third parties such as Chevron. In addition, increased pipeline and fractionation volumes in several key regions such as Oklahoma and Louisiana offsetting the slight volume decreases in North Texas.

For 2016 management is expecting Adjusted EBITDA and DCF to grow about 12%, and 10.5%, respectively thanks in large part to its $1.55 billion January 2016 acquisition of Oklahoma assets from Tall Oak Midstream LLC.

Does the payout profile agree with Wall Street's bearish valuation?

• Yield: 15.3%
• 2016 DCR guidance: Approximately 1.0
• 5 Year Analyst Annual Distribution Growth Projections: 0%

EnLink Midstream Partners' sky-high yield indicates that Wall Street thinks there is something deeply wrong with this MLP, such as no obvious long-term growth catalysts, and a distribution that balances precariously on the knife's edge of unsustainability.

But as long-term investors know the key to market beating returns is to recognize when Wall Street is wrong and badly mispricing an equity. Are current growth and payout concerns about EnLink Midstream justified?

Based on management guidance of moderate growth in DCF it would initially seem not, however always remember to take guidance with a grain of salt because it's based on assumptions that can easily prove wrong. For example, EnLink needs to generate $524 million in DCF to hit its 2016 per unit distribution target of $1.56.

Management's DCF guidance range of $545 million to $625 million seems to provide adequate security for this payout plan BUT is predicated on respective oil and gas prices remaining between $27.5 per barrel and $60 per barrel, and $2 per MMBTU, and $4 per MMBTU.

While crude currently trades in this range, gas prices don't. Should energy prices fall over the next year EnLink's DCR could fall short and endanger its generous payout.  

Can liquidity and balance sheet drive growth to prove Wall Street wrong?
Whether or not EnLink Midstream is worth buying comes down to just two questions: is the payout sustainable? And can the MLP continue growing it in the long-term?

To answer the first question requires checking to make sure that EnLink's cash flows are protected by long-term, fixed-fee contracts that also ensure volume stability.

Source: EnLink Midstream Partners investor presentation.

With 95% of 2016's operating margin derived from fee-based contracts, including substantial volume guarantees from major customers such as Devon Energy, it appears that EnLink's DCF is indeed stable.

Meanwhile EnLink Midstream's nearly $1.1 billion in available liquidity under its $1.5 billion credit revolver seems to back up management's claim that it won't need to raise any extremely expensive equity growth capital in the short-term.

However, given the 5.0 debt/EBITDA or leverage ratio limit imposed by the debt covenant connected to that facility, its not certain that this will truly be the case. In which case investor's need to consider the fact that EnLink Midstream's 12 month trailing cost of capital of 10.28% far exceeds its return on invested capital of 3.5% when adjusted for its $1.56 billion impairment charge.

Bottom line
Income investor's need to be aware that Wall Street's apparent ridiculously undervaluation of EnLink Midstream represents a valid concern over the ability of the MLP to continue growing profitably given extremely challenging market conditions.