Enterprise Products Partners L.P.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

A midstream energy company that primarily transports and stores natural gas, natural gas liquids (NGLs), crude oil, and refined products, with operations encompassing pipelines, processing facilities, and storage assets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Enterprise Products Partners L.P. (EPD) is a prominent player in the midstream energy sector, meaning they are focused on the transportation, processing, and storage of oil and gas commodities, as opposed to exploration or production. This business model shields EPD from much of the volatility associated with commodity prices since their revenue is largely tied to contracted volumes and fees rather than the price of the commodities themselves.

Business Overview:

  • Revenue Distribution: EPD generates revenue from four primary segments: NGL Pipelines & Services, Crude Oil Pipelines & Services, Natural Gas Pipelines & Services, and Petrochemical & Refined Products Services. These segments each play a role in moving and processing energy commodities from production regions to end users. While volumes are important, EPD is largely shielded from volatility of commodity prices due to contractual minimums and fees.
  • Industry Trends: The energy industry is undergoing a transition with increased focus on low-carbon fuels and renewable sources. However, given global energy demand, natural gas and its related infrastructure will remain vital for the foreseeable future. EPD is well-positioned in this energy transition given that natural gas is a necessary element in reducing dependence on dirtier sources.
  • Margins: EPD’s gross operating margin is largely influenced by tariffs, throughput, and operating costs. They can benefit from increasing transportation tariffs and increasing demand, but are also vulnerable to fluctuating costs and underperformance from assets. A lot of the costs are fixed, so a higher volume of throughput, without many additional costs, increases margins.
  • Competitive Landscape: The midstream energy sector is fairly competitive with various large integrated players as well as smaller operators. EPD’s edge comes from its extensive network of energy infrastructure which is extremely difficult and expensive for competitors to replicate. Other competitors have a similar business structure, for which the barriers to entry are lower. EPD is one of the largest players in the sector, giving it cost of capital advantages.
  • What Makes the Company Different: EPD’s extensive network of assets spanning across the country, and it’s concentration on natural gas and NGLs, as opposed to crude oil and petroleum products, are its greatest advantages. In addition, EPD has a history of operating efficiency which is crucial for the sector.
  • Other Key Facts: EPD is a partnership, not a corporation and pays distributions instead of dividends.

Financials in Depth:

  • Revenue: EPD experienced modest revenue declines in 2023, mostly due to lower commodity prices. However, volumes have been strong, partially offsetting the revenue impact of price declines. The Partnership relies on long-term fixed fee contracts and demand for its facilities, which somewhat protect it from volatile swings in oil and natural gas prices, but does not totally eliminate them.

Although revenue has decreased from the prior periods, EPD’s profitability is not greatly impacted due to its diverse business model and fixed costs nature.

  • Operating Income: Operating profit margins have also suffered due to higher costs and expenses. Operating expenses have increased due to inflation and higher energy prices, alongside increased costs associated with maintenance. However, these rising costs have been partially offset by increasing operating revenues due to strong demand.
  • Net Income: EPD’s net income has decreased substantially as a result of the previously mentioned points. The reduction in net income shows EPD’s vulnerability to fluctuations in energy prices and the cost of operations and maintenance.
  • Cash Flow: EPD’s operating cash flow decreased to $6.7 billion from $8.0 billion year-over-year. This shows that while they are generating cash from operations, they have had to face headwinds that reduced their ability to produce excess cash. EPD uses available cash from operations to cover capital expenditure, distributions, and debt servicing.
  • Debt: EPD has a moderate debt level, with long term debt of about 29B, which it uses for financing its operations and expansion. It has a debt-to-capital ratio of about 48 percent.
  • Capital Allocation: A significant portion of cash is used for CapEx, acquisitions, and distributions. Given EPD’s partnership status, a large percentage of cash flow goes to distributions to shareholders.
  • Guidance: EPD management notes an expected increase in NGL production throughout 2024 and expects continued cost cutting measures for the future.

Moat Analysis (3/5):

  • EPD has a narrow economic moat. The company benefits from economies of scale and unique infrastructure that provides a durable advantage over smaller rivals.
  • The company’s moat is less wide because other large integrated midstream companies have a similar advantage through their extensive scale and infrastructure.
  • It does provide some switching costs through long-term contracts but these contracts are often subject to renegotiation.
  • It is somewhat vulnerable to pricing changes and regulatory shifts, meaning that its advantage can be eroded.

While EPD’s moat isn’t as durable as a business with intangible assets or network effects, its geographical advantage, scale, and integration provide a strong and sustainable barrier to entry compared to a lot of other businesses.

Key Risks to the Moat and Business Resilience:

  • Regulatory Risks: Government regulations, especially those related to pipelines and oil and gas, could substantially affect costs and profitability. Future changes in regulations concerning environmental compliance or rates could hamper EPD’s growth prospects and returns on capital.
  • Demand for Oil and Gas: A shift away from fossil fuels toward renewable sources poses a challenge. While EPD is largely focused on natural gas, it is possible it could see a decline in demand in the future if regulations increase preference for greener sources.
  • Commodity Prices: Although the fees and volumes that EPD receives are fairly shielded from fluctuations in commodity prices, a prolonged depression or volatility in commodity prices can affect the company’s ability to sign contracts, and therefore profitability.
  • Weather Events: Extreme weather events may cause delays in transportation, damage to infrastructure, and decreased volumes on the pipelines, impacting profitability and cash flows.

EPD is vulnerable to financial crises. During the COVID-19 market downturn in March 2020, the stock price tumbled by more than 50%, in part due to investors fearing that some producers of crude oil would default on their contracts and that the prices for pipelines would be reduced. This is a constant risk.

  • Counterparty Risks: Since a major part of EPD’s operations relies on contracts with mid and downstream companies, a risk exists that these companies may default or renegotiate their contracts due to financial difficulties.

Understandability (2/5):

  • The midstream energy sector is quite complicated with numerous aspects that can be challenging to wrap one’s head around.
  • The business of pipelines, processing, and storage is fairly tangible. The business model is relatively straightforward, but the large scale of the operations and long term contracts make it hard for an average investor to track changes to profitability.
  • However, understanding the complexities of the partnership structure, various contracts, different types of assets, and varying regulation can be challenging for investors.
  • Given the numerous moving parts to the business, it is quite a bit harder to understand than most other companies, which usually focus on one single model, rather than many.

Balance Sheet Health (4/5):

  • EPD’s balance sheet is fairly strong. It has a moderate debt level that is coupled with predictable and stable cash flows from its operations.
  • The company seems to use a majority of its cash flow to return capital to shareholders through its massive distribution program. EPD is a master limited partnership which benefits from not having to pay corporate income tax. This makes it a good income instrument in many portfolios, due to predictable income.
  • This high dividend payout can make EPD have lower safety due to lesser retained earnings and increased reliance on debt, however it can also be seen as an advantage as it is an income focused stock.

EPD has a strong tradition of distributing a large percentage of their earnings as dividends. This has been a great way for investors to earn a considerable income over time. But it also means that less cash can be used for new business investments. In addition, there are high risks in the sector, such as a debt restructuring or a force major event, which may hamper EPD’s cash distribution and overall profitability. These are very rare events though.