Enterprise Products Partners: Poised for Growth Amid AI and Energy Demand

Enterprise Products: Our Income Account Bought For AI Tailwind (NYSE:EPD)

This idea was discussed in more depth with members of my private investing community, Envision Early Retirement. Learn More " We recently started a position in Enterprise Products Partners L.P. (NYSE:EPD) for our income account. As communicated in this brief post, the position was to replace our Verizon shares, which we terminated recently. Before I dive into EPD further, I must first take a step back and say a few quick words about our overall investing strategy. I use a so-called barbell model to manage my family investment portfolio. As detailed in my earlier article, ...contrary to the popular advice of building "a" retirement portfolio or "the" perfect retirement portfolio, we always hold two portfolios: one for short-term survival (e.g., a visit to the ER next month) and one for long-term growth (e.g., take care of things when we are 90 years old and estate planning for kids and grandkids). Isolating long-term and short-term risks is the first step of diversification. And we suggest you do the same at ANY stage of life - just adjust the amount of funds you put in each end of the barbell. Under this overall philosophy, my thesis here is to explain why EPD is an excellent choice for the income end of the barbell. In the remainder of this article, I will elaborate on the following considerations: First, EPD currently yields about 7.16% (see the next chart below), providing a very high current income both in absolute and relative terms (e.g., it is significantly higher than Verizon Communications Inc. (VZ) shares we sold recently). What's more important are the growth rates and consistency. As a dividend champion, EPD has been growing its dividends consistently for the past 25 years. Enterprise has one of the best and most resilient operations in the midstream sector in my view, to be elaborated on more later. And the growth rates are quite robust, as demonstrated by the second chart below. The YOY growth rates dropped sharply during the pandemic, but shortly recovered to be above 4% per annum (which is also about the average growth rate in the past 10 years). Later, I will explain why I anticipate such a healthy growth rate to continue given our future power, especially the need driven by AI technology and high-end manufacturing. Finally, the valuations are very reasonable despite a robust growth outlook. I assume you are familiar with the challenges and opportunities surrounding our AI technologies. These issues range from technological to ethical and legal. Among all these issues, a less-often discussed, but a crucial issue in my view is energy cost. As argued in my recent article analyzing NVIDIA Corporation's (NVDA) new Blackwell chips, ... each of Nvidia's H100 chips consumes 700W of energy at peak operation. This is more than the power consumption of the average American household. Collectively, NVDA's high-performance AI chips are estimated to consume more energy than many small nations as you can see from the chart below. Even for one data center, which typically employs thousands to tens of thousands of these chips, the peak power consumption can overload the power grid of a region or even a state according to the following comments from Microsoft engineers (see the second chart below). Besides AI, our digital future also includes other power-hungry technologies such as cryptocurrency, intelligent manufacturing, etc. (see the next chart below). I believe EPD would benefit greatly from utilities building new baseload facilities to meet such future power needs. The demand for electricity in the U.S. has been growing rapidly over the past few decades. However, certain regions of the country have had issues bringing new gas-fired power plants online. The reindustrialization of America (again, led by AI and other digital technologies) requires enormous amounts of electricity, and my view is that the country has been underinvesting in its power-generating capacity for years if not decades. EPD is a leading integrated provider of natural gas and natural gas liquids ("NGLs") processing, transportation, fractionation, and storage services in the country (with some Canadian exposure too). The main operation of EPD is precisely the transportation of natural gas from one location to another. Given my outlook for our growing power need, and especially the geographical unevenness of such need, I expect EPD to see its profitability climb in tandem as we construct more power capability. Next, we will see that EPS is indeed well-positioned to help us meet this need. To meet our future energy needs, EPD has many sizable construction programs ongoing. It is involved in most shale plays in the United States, and it is one of the biggest members in this space. For example, it intends to spend $3.5 billion both this year and next to expand its operations. As of April 2024, Enterprise had $6.9 billion worth of projects being developed. To better contextualize things, the next chart shows its CAPEX expenditures in recent quarters (top panel). As seen, the expenditures have been trending up substantially in the past 1~2 years. However, thanks to its strong cash generation and solid balance sheet, the company is in a good position to fund its capital projects sustainably. As you can see from the bottom panel of the chart above, despite the increased CAPEX expenditure recently, its cash flow to CAPEX ratio remains slightly above its historical average (a high ratio means better capital allocation flexibility). The balance sheet is sound, too. Many midstream companies are overleveraged due to their heavy dependence on borrowed funds to finance new projects. In Enterprise's case, only about half of its total capital consists of debt. The partnership receives strong credit ratings with a stable outlook (see the next chart below). Despite the growth potential and solid financial position, the stock (or the unit to be more precise, given its MLP status) is reasonably priced. As you can see in the top panel of the chart below, in terms of P/CFO ratio, EPD is currently priced at a ratio of 7.68x at the price of this writing, very close to it (only about 3% higher). As a midstream stock, EPD uses more leverage than the general economy. As such, it is important to take a look at its leverage-adjusted valuation metric too. The bottom panel shows EPD's EV/EBIT ratio compared to its historical averages. As seen, this metric points to the same conclusion of a very reasonable valuation. Its current EV/EBITDA ratio is 10.2x, again essentially on par with its historical average of 9.97x. In terms of downside risks, I assume investors are all familiar with the common risks facing EPD and other similar midstream companies. These risks include fluctuations in oil prices, fluctuations in natural gas prices (often exceeding those of oil prices), environmental regulations, et al. For EPD, there are some additional risks to consider. First, given its vast network of facilities, pipeline spills and damages are always a risk. The possibility of potential incidents (either due to natural disasters or facility malfunction) can cause significant financial impact and also reputation damage. Second, EPD's current focus remains on hydrocarbon fuels and has very limited exposure to renewable energy sources (which is an area some of its peers are investing in). Such lack of exposure may expose EPD to the threat of competition from renewable energy providers. However, I think this is a very remote threat. My view is that given the increasing demand for our energy needs, renewables will not be even enough to meet the INCREASE in our demand. In other words, I expect robust growth for "traditional" energy sources such as natural gas also (see the next chart). All told, my conclusion is that EPD is an excellent opportunity for accounts oriented towards income generation. To recap, EPD offers a well-rounded package combination with a high current yield (over 7% currently), healthy dividend growth rates, remarkable consistency, and reasonable valuation. Looking ahead, I anticipate the growth rate to continue at a robust pace given our future power demands, especially those driven by the expansion of AI applications and other power-hungry digital technologies.

Enterprise Products Partners: Fueling Dividends Through Increased Natural Gas Demand

Natural gas demand is estimated to continually increase through 2030. EPD plans to spend $3.25B throughout 2024 to ensure they can capitalize on growing demand. I consider myself a bit of a hybrid dividend investor because I've found success in the mixing of traditional dividend growth stocks accompanied by higher yielding asset classes. This includes different asset classes such as REITs, Business Development Companies, Closed End Funds, and Master Limited Partnerships. I really value the sense of security that an additional stream of income provides me in life, and I gave committed to growing this stream of income year after year. These alternative asset classes may be less popular in nature because of their complex inner workings, but this is a level of risk that I believe many investors should be open to taking if it's ultimately beneficial. However, I genuinely believe that including these asset classes into your portfolio is the 'secret sauce' to producing higher levels of dividend income a lot quicker. Enterprise Products Partners (NYSE:EPD) operates as a master limited partnership and remains my largest exposure to MLPs. Master limited partnerships are unique asset classes because they typically earn at least 90% of their income from sources related to natural resources or commodities. EPD is one of the largest partnerships and USA-based provider of midstream energy services. They tend to generate their income from sources such as natural gas, crude oil and refined products, and petrochemicals. Therefore, EPD is my choice for maintaining exposure to the energy sector. What makes a lot of investors shy away from MLPs is the tax burden that's passed along to investors and the spooky K1 form that investors receive, which I will talk about later. MLPs do not pay federal income taxes at the corporate level because these are passed through to the investors, who then pay taxes at their individual rates. I strongly believe that if you want to quickly grow your dividend income, you must be open to including an asset class like MLPs. For instance, the dividend sits at a very comfortable 7.1% at the moment. Earnings performance has remained consistent over the last five years. EPD generates their cash through four main segments: NGL, Crude Oil, Natural Gas, and Petrochemicals & Refined Products. If we take a look at the most recent Q1 earnings reported at the end of April, earnings per share landed at $0.66. Revenue amounted to $14.7B for the quarter, representing a large year-over-year increase of 18.6%. However, one of the most important metrics to measure when taking a look at MLPs are the DCF (distributable cash flow) totals. This is because the DCF total is a measure of the cash generated by EPD and is a good indicator of whether or not the business is growing. We can see that the total operational DCF for the quarter amounted to $1.94B, which is a slight year-over-year growth from the prior Q1 total of $1.91B. DCF is also important in terms of measuring whether or not the distribution can be fully covered. At the moment, the distribution coverage is strong and current earnings present no worries regarding potential cuts. Coverage is measured a bit differently than the typical 'dividend payout ratio' that you'd normally see as a metric for other dividend stocks, since it comes directly out of DCF. EPD has a current coverage ratio of 1.7x, which is very strong and can be seen as a 170% distribution coverage rate. Since 2017, EPG has managed to increase their adjusted EBITDA at a compound annual growth rate of 9.1%. Additionally, the companies continue to maintain a low leverage of only 3.0x, which has steadily decreased year over year from 2017's leverage ratio of 4.1x. EPD remains my go-to pick for midstream exposure due to their incredible resilience through periods of uncertainty in the market. Operational DCF per unit continues its upward trajectory for nearly two decades now. EPD is very reliant on natural gas pipeline volume since this is how a bulk of their revenues are generated. There's a direct correlation to EPD's earnings through the fees it can charge for transporting natural gas through its pipelines. Hence, higher volumes of transportation result in higher revenues and, thankfully, volumes have remained consistent and showing signs over growth year-over-year. Looking at this helpful graph compiled by Seeking Alpha, we can see that Q1 showed natural gas volumes of 18.6 Trillion British thermal units per day. Forward-looking, data compiled by McKinsey indicates that the global demand for gas is projected to grow past 2030 in all scenarios. This can be attributed to its wide range of uses across many different sectors. To be more precise, the growth is estimated to fall between the 10% to 15% range over the next decade. This would hugely benefit EPD going forward for a few different reasons. As demand increases, I anticipate this translating to higher volume levels that EPD can continue to capitalize on. Higher demands would also serve as a nice backdrop to add to the predictability of EPD's distributable cash flow over time. If volumes continue to increase, this also presents the possibility that there will be more opportunities to diversify their customer base, which can help reduce any region-specific risks. We've already seen volume increase across all operating segments. For instance, equivalent pipeline transportation volumes increased to 12.3 million BPD for the quarter, up from the 11.8 million BPD from the prior year. NGL, crude oil, and refined products volume also increased to 7.4 million BPD, up from the prior year's total of 7.1 million BPD. The bull case is strong for the sector, as Wells Fargo also thinks that artificial intelligence will play a strong role in growth going forward. The consensus is that they believe that midstream energy companies that are focused on natural gas will ultimately benefit from the build out of data center capacity as demand and tech development both continue to grow. They believe that the current production capacity and reserves are sufficient to meet the growing demands and I believe the same to be true for EPD based on their smart capital allocation strategy to fuel growth. I feel confident that EPD will take advantage of this increased level of demand as the company continues to shovel a growing amount of cash towards capital expenditures. EPD plans to allocate $3.25B towards capital expenditures throughout 2024, $550M in 2025, and another $3.25B throughout 2026. Total liquidity remains strong, consisting of $4.5B of available credit and unrestricted cash. Wall St. and Seeking Alpha's Quant seem to both agree with this outlook. Wall St. has an average price target of $33.13 per share, which represents a potential upside of 12.7% from the current level. The highest price target sits at $37 per share and the lowest is at $30 per share. Notice how all of these price targets remain above the current price level, which indicates a positive outlook. Additionally, Seeking Alpha's Quant rates EPD as a strong buy with a rating of 4.54 and has had a strong buy rating issued for over two consecutive months now. Since the main focus here is continued income generation, I plan to continue accumulating to benefit from the growing demand. The dividend of EPD continues to get increased over time, having a recent raise of 1.9%. As of the latest declared quarterly dividend of $0.525 per share, the current dividend yield sits at 7.1%. At the very beginning of my investing journey, I would frequently hear the statement that "the higher the yield, the higher the risk". I've since come to learn not to listen to these sorts of black and white statements because as an investor, a lot of money can be made in the gray area. After all, EPD has managed to increase their distributions for over 25 consecutive years in a row, never having to reduce or eliminate their distributions to shareholders. Despite the yield already being so high, EPD has managed to increase the dividend at a pretty sufficient rate to enable serious income compounding over time. For instance, the dividend has increased at a CAGR (compound annual growth rate) of 3.86% over the last decade. On a smaller time frame of three years, the dividend growth is stronger at a CAGR of 4.28%. This sort of growth has allowed long-term investors to enjoy an inflated yield on cost. For example, three-year holders would now be enjoying a yield on cost of 8.25%. This sort of growth makes it possible to compound your income over a short period of time, which is why I choose to include it as part of my dividend focused portfolio. For instance, let's calculate the dividend income received from an initial investment of $10,000 a decade ago. Let's assume that you reinvested all distributions received back into EPD to accumulate more shares. Let's also assume that you consistently invested an additional $500 per month into your EPD position throughout the entire holding period. In year 1 of your investment, you would have received about $535 in annual dividend income. If we fast forward to 2023, the total distribution income that you would now be receiving is about $6,864. This means that your dividend income from EPD would have grown by over 10x over the last decade. Assuming that EPD can continue to grow their earnings at a consistent rate to cover future distribution increases, we can expect this stream of income to continue growing over time. However, something very important to note about the distributions received from EPD are that they are not classified as qualified dividends. Speaking from my own experience through Fidelity, the distributions received from EPD are typically classified as return of capital. Distributions with this classification are not typically taxed immediately, and instead have the unique benefit of reducing your cost basis. Continued reinvestment and collection of the distribution will continue reducing your cost basis over time. As a result, when you decide to sell an MLP, the lower cost basis would likely mean that there's a greater capital gain that will be captured. At that point, the capital gain is then taxed at its respective rate, depending on your circumstances. I would consult with a tax advisor for more specifics on the matter. As a result of this structure, you will be receiving a Schedule K1 tax form. From my personal experience, filing your taxes with this form isn't difficult, and many investors let this one thing stop them from making the leap into MLPs. The only downside to the schedule K1 form is that it comes a bit close to the deadline for taxes in April, so you may have to file a bit later than you'd like. Due to the sector EPD operates within, there will also be some vulnerabilities that can slow down growth and shift plans. For instance, there are regulatory risks that may take place throughout the energy industry. Laws that effect EPD's pipelines could slow down growth. Not to mention, growing care for environmental protection also presents some potential vulnerabilities over the next decade. Pipelines will always have a risk of leaks which can be extremely harmful for the environment and this could lead to losses tied to legal ramifications. There are also vulnerabilities to politics and different trade policies that may reduce the amount of global demand for natural gas and other commodities. If the actual volume and demand levels do not align with the previously mentioned forecasted expectations, investor capital could flow out of the sector and cause declines. Forecasts are just estimates, and they can be incorrect due to a variety of unforeseen influences. In conclusion, EPD remains my top choice for MLP exposure. The performance consistency for over two decades reinforces the company's ability to operate efficiently through all market cycles. Additionally, the current distribution remains well-supported by distributable cash flow and capital expenditures should help the business continue to grow at a capacity that can handle increased demand over the next decade. The high distribution yield packs enough of a punch to compound dividend income when held over a long period of time. For this reason, I am giving EPD a Buy rating.

Enterprise Products Partners: NGL Value Chain Promises Continued Distribution Growth (EPD)

I maintain my BUY rating for income and dividend growth investors. Lately I've seen several narratives that Enterprise Products (NYSE:EPD) will benefit from increased natural gas consumption associated with AI data centers. I am personally not a subscriber to this thesis based on EPD's assets and business model. So what I decided to do was update my previous thesis, which included the potential impact of the SPOT project. This time around, I analyzed the potential impact of the multiple projects in the NGL value chain. This is EPD's most profitable segment representing 53% of the company's operating margin. The multitude of gas processing plants, fractionators, and NGL pipelines have allowed me to increase my growth rate projections for EPD. I project EPD is able to sustain a 5.5% CAGR in operating margin through 2028 giving investors confidence of future distribution increases. This analysis comes on the back of yet another distribution increase on July 10th. The quarterly distribution was raised by $0.01 to $0.525/unit, bringing the current yield to 7.2%. I expect the 26 year streak of distribution increases to continue thanks to many expansion projects in the NGL and crude value chains. I continue to rate EPD as BUY and own units of the company for myself and my family. The NGL component of Enterprise generated 53% of its total operating margin in Q1. The NGL product stream starts at the natural gas processing plant which extracts the liquid components. This is a mixture of propane, butane and ethane. This product stream is simply referred to as NGLs. The NGLs then flow to fractionators to be separated into individual components for exportation or domestic consumption. The company is investing heavily in the NGL side of the business to continue to exploit the high margins this segment can provide. Following the recent completion of the Leonidas and Mentone 3 natural gas processing plants, the company continues to push the envelope for its value chain in all aspects of the business. There isn't a single part of the NGL system that isn't getting bigger. EPD has three additional natural gas processing plants, the Bahia pipeline, Frac 14, and multiple export terminals under construction. Beyond just getting bigger, this strategy sets up a domino effect where each new asset feeds into another down stream asset. This allows EPD to extract value at each step in the process from the wellhead to the docks. As highlighted below, the new processing plants will help fill the Bahia pipeline. 70% of the volumes on this pipeline are expected to come from an EPD processing plant. Then, the NGL stream stops at Mont Belvieu for fractionation prior to exportation at the Enterprise Hydrocarbons Terminal. In 2H 2025, EPD is expected to commission the Neches River Export terminal to give it a second location to export ethane and propane. Digging further down, we can find that the NGL pipelines and terminals generate the highest amount of earnings in the NGL space, accounting for more than half of the total NGL value chains profit. This is shown by the red box in the figure below. Why is this so important? First, lets quantify how these projects will impact the volumes on the EPD system compared to Q1 volumes To get a financial grasp on what these projects are bringing to the table, we can extrapolate using a quarter over quarter comparison. In 2023, EPD brought online two processing plants and fractionator #12. The financial impact of these projects was presented in the Q1 earnings presentation (slide 10). Using this data I was able to extrapolate the impact of the additional volumes through the EPD system. I also factored in a slight margin reduction to account for changes in processing and fractionation margins. We can see that this adds approximately $1.3 billion in gross operating margin on an annual basis. This is significant enough to increase the entire company's earning potential by 14% from 2023 levels. NOTE: The Houston Ship Channel Dredging Project is expected to increase vessel traffic at EHT and Morgan's Point Export Facilities. The company projects this will allow its terminals to increase volumes by 12-15%. This provides upside to the estimated returns listed above As you would expect from a great company like EPD, it is thinking multiple years down the road with each of these high value projects. The Bahia pipeline and terminal projects are all upgradable from the currently advertised capacities to provide for capital efficient growth opportunities. Justin Kleiderer, SVP Pipelines and Terminals, spoke on how the Bahia pipeline can be upgraded over time. So you think about a metric of every new gas plant we put on, we yield about 40,000 barrels to 45,000 barrels a day of NGLs into Bahia. So we're growing our footprint both in the Delaware and the Midland. ...we picked 600 for the reasons before, but you think of a 30 inch pipeline. If it's fully horsepower, it could do upwards of a million. But we're trying to be capital efficient about how we phase into it. So if our forecast are right and we need more than what we have today, we can add pumps on it to upsize it. This implies the potential for the Bahia pipeline to have sufficient capacity (when upgraded) to accommodate several additional gas processing plants. This would also imply the need for at least one and possibly two additional fractionation facilities. This falls right in line with the company's projection for NGL production in the later stages of this decade. In my last article on EPD, I really focused on what the potential impact the SPOT project could have for EPD long term. Since then, the project still has not reached official FID, but the company was able to provide additional details how contracting was progressing and when they expected to formally issue FID for the project during the Q1 conference call. Brent Secrest - Chief Commercial Officer We expect to have two contracts by the end of call it next month. And then we're in ongoing discussions with other counterparties to commercialize that. But, yes, the mindset is, we're not going to move forward on that project until we have the contracts to support that project. I think we'd like to target before the end of this year to go forward on that project. In a similar pattern to the domino effect created in the NGL value chain, SPOT has the potential to have the same effect in the crude pipeline network. I previously projected that SPOT has the potential to add $900 million in gross operating margin through 2028 (after the three year building period). In my previous analysis I assumed the company continued its historical performance of achieving 13% ROIC from its growth projects. Using the NGL build out estimations provided above, I have updated this projection. The projected performance of the NGL projects have increased my forward GOM projections by $550 million. This would allow EPD to sustain a 5.5% CAGR through 2028. This growth rate would exceed the company's guidance to grow the distribution by 5%. To me, the provides a fair amount of safety margin, should certain assets underperform, that EPD can sustain its target of 5% annual distribution growth. More importantly, one of my favorite things I like to highlight about EPD is that its not just yield play. Over the long term, the unit price follows the yield. Therefore, as the yield continues to grow, I expect the unit price to continue to appreciate in a similar manner to how the stock has performed over the last three years. The outlook for the company, combined with a 26 year track record of raising the distribution make for a powerful thesis for ownership of EPD units. However, with consistent performance typically comes a higher price tag. When measuring the valuation metrics by both EV to EBITDA and Price to FCF, EPD is one of the more expensive options out there in its peer group. NOTE: The peer group was selected using large cap master limited partnerships only. C-Corps were not used in the comparison. EPD is also has the lowest yield of the four companies compared here. However, the track record combined with a high level of distribution coverage and my financial projections above give me confidence in EPD for the long term. The company is conservatively managed and operated for on a multi-year horizon. I believe EPD still represents compelling value to long term value for income oriented and dividend growth investors alike despite the expensive valuation compared to peers. The growth trajectory I have outlined here implies the successful completion of over $10 billion worth of capital growth projects that are in various phases of completion. There are any number of regulatory or physical challenges that could delay and/or drive up the capital costs of these projects. In particular, the assumption of SPOT entering operating is the largest singular risk in this analysis. The project has not formally reached FID and construction is yet to begin. Should this project not reach FID or be meaningfully delayed, this would significantly alter the financial model provided above. In this scenario, investors would most likely face a stunted distribution growth rate. The company would also potentially trade at a lower multiple due to lower growth expectations. 1. The NGL value chain represents the bulk of EPD's earning potential. 2. Significant growth can be realized from the current projects under construction in the NGL segment. 3. With the addition of SPOT, EPD should be able to maintain a 5% distribution growth rate through 2028. 4. The unit price usually follows the distribution. Investors can expect capital gains as well as yield with EPD. 5. I maintain my BUY rating for income and dividend growth investors.