3/20/2020 5 star rating Highlights:
The firm has built out a dominant position in natural gas liquids. Its Houston Ship Channel (where Enterprise has invested over $8 billion in the past few years) and Beaumont Terminal and its Mont Belvieu assets (NGL fractionation, storage, pipelines) means it will be the primary beneficiary as U.S. NGL exports increase in the coming years. We view the forthcoming NGL demand-pull toward the Gulf Coast as the key growth driver for Enterprise. From its vast NGL system, Enterprise's connection with every ethylene cracker on the Gulf Coast, its sold-out PDH splitter (and its second PDH plant is on the way), and the upgraded isobutylene unit make it adept at converting low-cost NGLs into higher value-added olefins.
In a more challenging midstream environment in 2020, the focus, in our view, will be on capital allocation. Enterprise has a massive $7.7 billion backlog of work, which will support growth over the next few years. Growth capital spending should fall to around $1.8 billion in 2021 from over $4 billion in 2019. Combined with minimal distribution increases, Enterprise will be in the highly attractive position of having excess cash after fully funding capital spending plans and distributions in 2020. If Enterprise chooses to fund half of its capital spending plans with debt, excess cash available for buying back units would easily surpass $1 billion annually. Yet, Enterprise has only announced around $130 million in planned opportunistic buybacks in 2020. Alternatively, if debt is not used as a funding effort, leverage will decline rapidly, and we estimate could be as low as 2.8 times debt/EBITDA by 2024.
We expect returns on invested capital to average about 11% over the next five years, well above the company's cost of capital of around 8% by our estimates.
A network of pipelines serving multiple end markets and supplied by multiple regions is typically more valuable than a scattered collection of assets. A pipeline network allows the midstream company to optimize the flow of hydrocarbons across the system and capture geographic differentials. Finally, it is typically cheaper for an incumbent pipeline to add capacity via compression, pumps, or a parallel line than it would be for a competitor to build a competing line.
Enterprise’s asset base quality is outstanding. For producers seeking options for their hydrocarbons, Enterprise offers an extensive menu. The partnership is connected to every major U.S. shale basin, every ethylene cracker, 90% of the refineries east of the Rockies, and offers export facilities out of the Gulf Coast. The heart of the asset base is clearly its NGL network, which is comprehensive and offers deep access to Mount Belvieu. Its regulated NGL network makes up 20,000 miles of pipelines across 27 states transporting over 1.8 million bpd. The unregulated assets include over 1 million bpd of NGL fractionation capacity, over 170 million barrels of storage, multiple export terminals with dock access, and isomerization units. To further its control over the NGL value chain, Enterprise has built out a number of petrochemical assets, including propylene pipelines, propane dehydrogenation (PDH), and isobutane dehydrogenation (iBDH) facilities, which allow the partnership to extract higher value olefins from feedstock. In effect, the firm is creating more of a demand pull for the ample supply of NGLs traveling through its network. Enterprise, in our view, was one of the first in the industry to recognize the shortage of NGL infrastructure in the U.S., and the eventual shift toward exports and has built an impossible-to-replicate collection of assets across the value chain, positioning it to capture differentials between U.S. and international markets.
Enterprise’s natural gas assets have been impacted by its considerable exposure to Eagle Ford and Haynesville where production is well off peak levels. Natural gas throughput at Enterprise has declined by about 10% since 2012, though it has seen some improvement in 2017 and 2018 off very low levels. Still, the impossible-to-replicate network makes up 12,000 miles of natural gas pipelines across New Mexico, Texas, and Louisiana with 400-plus interconnection points to demand centers as well as 5.8 bcf/d of net gas processing capacity. The vast majority of the network is in Texas, with 16 bcf/d of transport volumes and nearly 13 bcf of storage, which is about 80% contracted by our estimates. Enterprise has benefited more recently from its exposure to the Delaware/Permian basin, where rich gas volumes have more than quadrupled since 2013 by our estimates and the partnership has been added processing capacity to feed its existing asset base.
Enterprise’s 5,700 miles of crude pipelines are primarily located in Texas, Oklahoma, and New Mexico, connecting the Eagle Ford, Permian Basin, Cushing, and Gulf Coast exports hubs and transport about 1.8 million bpd. The firm also owns about 37 million barrels of storage. The reversal of the Seaway pipeline to flow oil to the Enterprise Hydrocarbons Terminal was a smart move, and the planned construction of a new pipeline transporting crude to Sealy (on the Coast) from Midland will strengthen the overall network. We’re particularly impressed with the partnership’s position on the Houston Ship Channel in terms of storage and export opportunities. The EHT controls 21 million barrels of storage with six deep-water dock ship and two barge docks, and can accommodate Suzemax tankers, which are the largest tankers that can navigate the channel. The firm also controls Beaumont West, Freeport, and Texas City systems, which adds additional dock access. We think the dock access is important, given geographic constraints, and it allowed the firm to export 34 million barrels of crude oil in 2016 following the lifting of the export ban in December 2015, as well as another 17 million barrels of processed condensate. Replicating Enterprise’s crude oil asset portfolio will be very difficult, in our view.
We view its marketing operations as a strong asset that lets Enterprise collect significant additional fees from its network versus being a pure toll-taker. With its marketing operations, Enterprise takes ownership of the hydrocarbon and seeks to exploit differentials based on time, location, or product arbitrage across the hundreds of connection points across Enterprise’s system. This type of asset is very difficult to replicate due to the complexity and richness of Enterprise’s system, and the few producers that do undertake marketing activities only focus on the relatively few basins they operate in versus the entirety of the U.S. oil and gas complex. It also lets Enterprise take full advantage of profitable opportunities in secondary markets across its pipelines for capacity not being used under firm contracts, versus ceding those fees to the shipper. Other examples would include taking advantage of seasonal changes in demand for propane, upgrade opportunities for raw NGLs to be converted to higher grade and more profitable olefins, and being able to use Enterprise’s network to move product to markets where differentials are the widest. Rather than operate as a separate group, the marketing operations are embedded within the natural gas, oil, and NGLs teams at Enterprise providing insights to help them make investments across the portfolio. Finally, we believe the marketing operations provide an added benefit in terms of sourcing and developing relationships with producers to serve as committed shippers for future investments but also sources of internal demand (e.g. opportunities to Enterprise to take ownership of hydrocarbons) to support incremental investments. Peers without this robust level of marketing operations will face higher hurdles in terms of being able to obtain commitments for large investments.
From a contract perspective, we have a favorable view. We estimate about 80% of Enterprise’s contracts are firm contracts by shippers to reserve capacity on Enterprise’s assets for a decade-long time frame, and the firm typically signs 15- to 20-year contracts for its pipelines. These industry standard contracts provide shippers with reserved capacity, for which they pay an origination fee, but do not obligate them to use the line if better opportunities exist elsewhere, for which the shipper would pay an additional transport fee. For Enterprise’s latest investments, which are the PDH plant, 100% of the 750,000 pounds per day are contracted for 15 years, and the iBDH plant is also fully contracted for 15 years, split between investment-grade companies and internal Enterprise marketing capacity. In times of market stress, we note that Enterprise has also been creative with its assets, obtaining area dedication contracts where the producers would be obligated to provide a certain number of barrels per day and then look to convert the contract to a long-term fee contract as the markets recover. We think this is supportive in terms of developing long-term relationships with important producers.
Fair Value and Profit Drivers | by Stephen Ellis Updated Mar 20, 2020
After updating our model to reflect lower capital spending levels in 2020 and 2021 and further fee and volume adjustments, we retain our $25.50 fair value estimate. Our fair value estimate implies a 2020 EBITDA multiple of 10.5 times, a 2021 enterprise value/EBITDA multiple of 10.8 times, and a 2020 distribution yield of 7%.
We expect the main driver for Enterprise will be its NGL segment, as the demand pull from the Gulf Coast and international markets lets Enterprise take advantage of the export opportunities and lucrative differentials via its comprehensive asset base. We also expect increased demand for ethane will benefit Enterprise as well, though to a lesser extent than peer Oneok, as Oneok’s fractionation plants have more underutilized capacity. However, the diversity of Enterprise’s asset base, its ability to take advantage of just about any profitable opportunity that appears in U.S. midstream, and its largely fee-based earnings stream all support healthy single-digit growth prospects over the next few years. We expect EBITDA to increase about 1% annually over the next five years and distributions about 1% annually on average over the same time frame.
Risk and Uncertainty | by Stephen Ellis Updated Mar 20, 2020
The single greatest risk to the Enterprise story is failure of demand for natural gas liquids from the petrochemical industry in the Gulf of Mexico to materialize. In addition to making up over 50% of the partnership’s gross operating margin today, Enterprise's NGL business will serve as its primary growth engine through the rest of the decade. We anticipate demand for ethane due to ethylene crackers under construction in the Gulf in the next few years. However, much of this demand is out of Enterprise's control. Any delays or reduced demand would have a materially negative effect on Enterprise's earnings. Even as much of the downside risk is mitigated by sufficiently contracted capacity, failure of NGL demand to materialize would cap Enterprise's earnings upside.
Enterprise holds some commodity price risk from both volumes and equity ownership of natural gas, crude oil, and NGLs. The partnership addresses some of this risk through hedges and its diversified asset base. We maintain that management’s efforts to vertically integrate insulates the business, proving natural hedges against much of the commodity price volatility. However, the main risk to Enterprise’s marketing business is a narrowing of spreads.
As with many yield-oriented investments, Enterprise is also exposed to interest-rate risk. If interest rates increase faster than expected, Enterprise units could underperform, as a steepening yield curve increases expected distribution yield for competing assets.
Enterprise’s executives, who represent some of the best and brightest in the industry. We see them as chess masters operating in an environment where everyone else is playing checkers. Beyond the depth of management’s experience in nearly every aspect of the energy and chemical industries, their consistent alignment with LP unitholders’ interests over time substantially differentiates them from their midstream peers. The continued participation (and reinvestment of approximately $100 million annually) from the Duncan family (the partnership’s original cofounder and general partner) in the LP is also a powerful endorsement. In 2018, the family added another $106 million in purchases in August on top of its expected annual $100 million contribution.
Leadership of Enterprise ceded from Michael Creel to Jim Teague in January 2016. Serving as COO since 2010 and with over 40 years of experience in the midstream and petrochemical industry, Teague is particularly well suited to the role (and one of the best managers of midstream assets in the industry). This has shifted to a co-CEO structure with Randy Fowler in 2020, a reflection of the way the pair has worked together for over two decades. The rest of the executive management holds similarly stellar credentials. The Duncan family also continues to preserve its legacy of sound stewardship, with Randa Duncan Williams, daughter of the partnership's late founder, chairing the board.
In a difficult industry environment, Enterprise has remained conservative and sensible stewards of capital. This is a tactical executive team that plays the long game. They retain sufficient distributable cash flow to reinvest in the business while limiting reliance on dilutive equity and debt capital market issuances. In particular, we view the Oiltanking acquisition in 2015 for a total consideration of $6 billion as a forward-thinking effort to capture growing export opportunities. In an industry that is more cyclical than most investors might have expected, we applaud Enterprise management’s prudent approach to achieving consistent, steady growth and returns. The recent achievement of self-funding the equity portion of its capital expenditure program a year ahead of schedule plus the announcement of a $2 billion unit buyback further cements the management team as worthy of our Exemplary rating.
Enterprise’s exemplary stewardship of its business mostly mitigates our concern about the limited rights of LP holders. Current governance structure affords LP unitholders almost no say in the management of the firm. As long as returns continue to grow and remain robustly above the cost of capital, we are willing to concede some control in corporate governance.
In Enterprise’s case, we continue to think the deep-seated apathy toward the firm is misguided, especially master limited partnership related concerns. Enterprise is unlikely to switch to a c-corp structure, given it can fund its spending program without issuing equity, and the need to issue equity to fund projects has forced similar conversions in the past, in our view.
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