Is This New Dividend Aristocrat Yielding 7% a Buy?

Enterprise Products Partners EPD recently raised its dividend for the 25th consecutive year, earning it Dividend Aristocrat status. There’s plenty to like about this master limited partnership: Morningstar thinks management has done an exceptional job of allocating capital, the company has carved out a wide economic moat. While the MLP’s units are no bargain today, income-seekers should keep this name on their watchlists.

Enterprise Products Partners has geographical and asset diversity that allows it to pursue growth in nearly any environment. It can aggregate supply of every type of hydrocarbon from multiple sources in major producing basins and deliver it to multiple end markets (refiners, petrochemicals, exports). Its robust marketing operations let it clip transaction-fee-like earnings in volatile oil and gas markets. With marketing spreads narrowing across the gas and petrochemicals markets, we expect Enterprise’s marketing performance to be weaker in 2023 than in 2022, though the outlook for the second half of 2023 has improved. The company has established a dominant position in natural gas liquids, supported by a strong petrochemicals unit that converts low-cost U.S. molecules into more-valuable exports. Enterprise was years ahead of its peers in recognizing the opportunity and has built out a sizable and, in our view, underappreciated business.

Key Morningstar Metrics for Enterprise Products Partners

• Fair Value Estimate: $27.50
• Star Rating: 3 Stars
• Economic Moat Rating: Wide
• Uncertainty Rating: Medium
  
  

Economic Moat Rating

We believe Enterprise Products Partners has a wide economic moat based on efficient scale. We expect returns on invested capital to average about 11%-12% over the next five years, well above the company’s cost of capital of around 8% by our estimates. While we consider Enterprise’s assets to be deserving of a wide moat on a stand-alone basis, we consider its export assets across natural gas liquids and oil to be key contributors to extending its competitive advantage over a longer time frame. Enterprise was among the first to recognize the value of U.S. exports to international markets and has been a leader in the market since it first developed in the mid-2010s. Key to its advantage is ownership over every part of the natural gas liquids value chain, allowing it to direct molecules to Enterprise assets and capture fees at each step in the way, including for export. Enterprise’s asset base quality is outstanding and easily merits a wide moat.

Read more about Enterprise Products Partners’ moat rating.

Fair Value Estimate for Enterprise Products Partners Stock

Our fair value estimate implies a 2023 enterprise value/EBITDA multiple of 9.1 times and a 2023 distribution yield of 7%. We expect the natural gas liquids segment to contribute more in 2023 due to new projects entering service, but this will be more than offset by weaker marketing spreads, particularly with the natural gas processing business. We expect the main medium-term driver for Enterprise will be its petrochemicals segment, as the demand pull from international markets for a variety of industrial applications lets the company take advantage of the export opportunities and lucrative differentials via its comprehensive asset base. We expect EBITDA to increase about 1%-2% annually on average over the next five years as new projects entering service are offset by weaker processing margins due to lower oil and gas prices and utilization over time.

Read more about Enterprise Products Partners’ fair value estimate.

Risk and Uncertainty

Enterprise’s major risk is a decline in natural gas liquids demand, as its NGL business makes up over 50% of gross operating margin today. However, its petrochemicals business looks to be the most important near- to medium-term earnings driver. Thus, any delays or reduced demand from international markets would have a materially negative effect on Enterprise’s earnings. Enterprise is also exposed to several significant environmental, social, and governance risks, including an eventual peak and decline of U.S. oil demand, as well as managing its carbon emissions and potential costs. Risks could include environmental damage from chemical waste that typically occurs around a manufacturing site, resulting in remediation and litigation expenses.

Read more about Enterprise Products Partners’ risk and uncertainty.

Enterprise Products Bulls Say

• As the largest player in the NGL market, Enterprise is most leveraged to petrochemical demand in the Gulf Coast and international markets.
• Its expansion into petrochemical activities insulates Enterprise from midstream cyclicality.
• Marketing activities allow Enterprise to extract additional fees from its asset base while providing insights into each of its markets.
  
  

Enterprise Products Bears Say

• The marketing operations depend on differential spreads that could continue to narrow without investments by Enterprise and third parties to spur demand.
• If the promise of a large increase in NGL demand from China and India never materializes, Enterprise is left holding the bag with export facilities.
• Without substantial growth in U.S. hydrocarbons, more of Enterprise’s assets risk being underutilized and thus seeing lower revenue and fees.