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Morningstar | Enterprise Continues to Set Records With 3Q During Strongest Environment in Recent Memory

Enterprise Products Partners had a good third quarter, set 16 operational and financial records, and is operating in the "strongest business environment we have seen in recent memory" per CEO Jim Teague. We plan to make some minor adjustments to our model, but we don't expect a material change to our $35.50 fair value estimate or wide moat rating. We consider units to be deeply undervalued, partially due to investors' frustration and disinterest with master limited partnerships in general, though we think that sentiment is improving, but largely because of a lack of appreciation of the strong underlying trends propelling Enterprise's natural gas liquids (NGLs) business forward.

This quarter presents compelling evidence that our thesis is playing out as expected. Enterprise, like NGL peer, Oneok, is benefiting from a blowout in differentials between Conway, Kansas, and Mont Belvieu, Texas, which are both significant NGL market hubs. The major reason for the blowout is a shortage of fractionation capacity at Mont Belvieu to handle the growing volumes of natural gas liquids being produced in the Permian, the Rockies, and SCOOP/STACK among other areas. We also believe Oneok's Sterling pipelines that move propane (and other purity products) from Conway, Kansas, and Mont Belvieu are maxed out, but pipelines that transport y-grade (or mixed NGLs) are not. In short, shippers faced with fractionation constraints at Mont Belvieu are increasingly fractionating NGLs at Conway, Kansas, then facing pipeline constraints transporting the purity products to Texas. To some extent, these issues are being made worse with the Mariner East II pipeline being delayed, which has caused additional propane to be railed to Conway from the Marcellus. We expect it may take until early 2020 to fully address these constraints. The demand-pull for these purity products is increasingly propane exports and ethane needed for U.S. Gulf Coast steam crackers starting up.

Enterprise is extremely well positioned to take advantage of this environment. The entity is clearly seeing incremental opportunities for investment, as its initial guidance for 2018 capital growth spending was $3 billion in January 2018, increased to $3.2 billion to $3.4 billion in April 2018, upped to $3.8 billion to $4 billion in August 2018, and is now expected to finish the year at $4.2 billion. Enterprise now has a $6.6 billion growth capital program. It is the largest fractionator at Mont Belvieu with over 600,000 bpd of existing capacity and is also the largest exporter of ethane, propane, and crude oil by our estimates. Enterprise just announced that it would add another fractionator to Mont Belvieu, in addition to the one already under construction, that will take its Mont Belvieu fractionation capacity to 1 million bpd by mid-2020. We expect these investments will be made at attractive 4 times to 6 times EBITDA multiples, driving forward future EBITDA growth. We also anticipate that Enterprise will benefit from higher pipeline volumes across its network as well as stronger marketing profits given the wider differentials that currently exist. We do consider Enterprise to have best-in-class assets at nearly every point in the value chain.

From a financial perspective, adjusted for mark-to-market, gross operating margin increased to $1.9 billion, a 43% increase over last year's levels, mostly thanks to the NGLs segment. Contributors include new projects that have come online, including the Midland-to-ECHO pipeline, the propane dehydrogenation facility, and new fractionation capacity at Mont Belvieu. Volume growth, particularly within NGLs, is an important factor, as pipeline volumes were up 14% and fractionation volumes were up over 30%. Given the wide differentials being reported, Enterprise's NGLs marketing gross operating margin nearly doubled to $397 million from last year. We expect growth to continue with EBITDA topping $7 billion this year and $8 billion by 2021.

In addition to the strong environment for NGLs, we'd also note Enterprise's strength across its oil segment, which is benefiting from strong export demand. U.S. oil exports hit 3 million barrels per day in June, and have been over 2 million bpd consistently in recent months, up from 500,000 bpd to 600,000 bpd last year according to the U.S. Energy Information Administration. Adjusted gross operating margin for Enterprise's crude business soared over 80% from last year, thanks to higher pipeline volumes, which included a 40% increase in crude oil export volumes to 632,000 bpd. We've seen a number of new export terminals announced by Enterprise and its peers lately to take advantage of the increase in export demand, but as usual, Enterprise recognized the trends early and is already the leader.

For more on our NGL forecast, please see our July Energy Observer, "The Natural Gas Liquids Rubik's Cube Solved." For more on midstream moats, please see our reports, "Midstream Energy Offers Efficient Scale Moats at a Discount" and "Investing in the Efficient Scale Moat Source" published in March 2018 and October 2018, respectively.