EUR 850.00 For Business Accounts Only

Morningstar | Enterprise Products Continues to Break Records in 1Q; Outlook Bright for Undervalued Partnership

Enterprise Products Partners reported a strong first quarter, breaking 11 operational and financial records. The partnership benefited from higher volumes across all of its key segments as well as contributions from new assets in service, resulting in both adjusted EBITDA and distributable cash flow increasing 18% over last year's levels to $2 billion and $1.6 billion, respectively. Free cash flow, which Enterprise is now highlighting to appeal to more generalist investors, increased nearly 90% year over year to $1.9 billion. The distributable cash coverage ratio is now a gaudy 1.7 times, allowing Enterprise to retain $665 million to reinvest in the business and not rely on equity issuances. 2019 looks to be a strong year, with production increases in the Permian driving volumes and higher crude oil exports (a record of nearly 900,000 barrels a day during the first quarter) plus 300,000 b/d of new ethane demand from ethylene crackers starting up in 2019. We don’t expect a material change in our $35.50 fair value estimate or wide moat rating. We continue to believe that investors underappreciate the quality of Enterprise's business and its leverage to higher volumes across all three hydrocarbons.

The business mix continues to remain heavily weighted toward fee-based at 83% during the first quarter, with 5% commodity-based and 12% differential-based. This mix is fairly consistent across Enterprise's four reporting units, with the petrochemicals and refined products business being the least fee-based at 80% and most of the remainder (15%) being differential-based. That said, we think the diversity of the businesses allows Enterprise to do well even when spreads across some of its businesses are narrowing.

For example, the natural gas processing, propylene, and octane enhancement businesses contributed $1.1 billion in gross operating margin in 2018. This was about 15% of Enterprise's overall $7.3 billion in 2018 gross operating margin. However, current spreads, which are around 2016-17 levels, suggest the business will generate about $900 million in gross operating margin in 2019. Despite the weaker spreads in the first quarter, Enterprise still reported gross operating margin of $2.1 billion, up 35% from last year.

Enterprise looks well positioned to reap earnings from new projects, having placed $1.9 billion of projects in service year to date with another $3.5 billion due to start up by the end of the year. 2019 growth capital spending is now expected to be a midpoint of $3 billion compared with $2.66 billion last quarter with the incremental spending largely being on projects $10 million and below, where Enterprise earns some of its best returns. A number of these efforts are petrochemical related, include an isobutane dehydrogenation plant and the ethylene export dock. Enterprise recently announced at its analyst day that petrochemicals gross operating margin, which was just above $600 million in 2018, would be over $1 billion "easily by 2025," no doubt due to contributions from these efforts. About two thirds of this income stream is fee-based, including its under-construction ethylene export dock. While not formally announced yet, Enterprise is working on developing a second propane dehydrogenation plant to meet long-term global demand for propylene, about 4% annually. This is a fee-based business, as Enterprise will purchase the feedstock based on an index and sell it based on the same index after factoring in its own operating costs of the plant and its required return.

We remain impressed by Enterprise's skill at taking advantage of opportunities in the market including the Permian Basin recently. Permian differentials blew out in 2018 before collapsing as new takeaway capacity was added, and one key project was Enterprise's Midland-to-ECHO 2 pipeline, where Enterprise converted an existing natural gas liquids pipeline to crude, moving more than 200,000 b/d out of the Permian. Enterprise was also able to bring the Shin Oak pipeline into service in February 2019, about four months ahead of schedule, which is now transporting 250,000 b/d. Now, a Midland-to-ECHO 3 pipeline is under development and is already seeing shipper interest, while Enterprise retains the option of converting the original Midland-to-ECHO 2 pipe back to NGLs if it is profitable to do so. Enterprise noted that concerns regarding the Permian being overbuilt from a crude takeaway perspective in 2019 shift to being underbuilt in fairly short order, particularly when it considers takeaway capacity to Houston and export markets, suggesting that pipelines moving barrels to Cushing and Corpus Christi would face greater challenges. Given our forecast for Permian volumes, we tend to agree that Permian takeaway capacity will tighten up.

After announcing a $2 billion buyback program last quarter, Enterprise quickly moved to start snapping up undervalued units with $52 million in purchases. We see this purchase as creating value, given the current undervaluation of the partnership. To be fair, it took roughly 20 years for Enterprise to complete its last buyback program, but the management team has been fairly explicit regarding its view on the units' undervaluation, so we expect purchases to be fairly steady.

For more on our NGL forecast, please see our Observer published in July 2018, "The Natural Gas Liquids Rubik's Cube Solved." Please see our research published in February 2019, "The U.S. Crude Export Boom and the Midstream Opportunity," for more on our crude oil exports forecast.