3 Reasons Why 7.5% Yielding Enterprise Products Partners Is The Buying Opportunity Of A Lifetime – Enterprise Products Partners L.P. (NYSE:EPD)

This article was co-produced with Dividend Sensei and edited by Brad Thomas.

This article is a Dividend Kings member request-response to highlight what Chuck Carnevale considers to be one of the “buying opportunities of a lifetime unless the business model completely implodes.”

That would be Enterprise Products Partners (EPD), the most undervalued 11/11 quality Super SWAN on the Master List, an anti-bubble stock, and one of my highest conviction recommendations.

My Retirement Portfolio EPD Buys

(Source: Morningstar) – 59 unit buy is actually 30 and 29 unit buys at the same price

Right now EPD is in free fall as the market sells off anything energy related on fears of a COVID-19 global recession.

I have no idea where EPD will bottom since its price is currently totally disconnected from objectively strong and improving fundamentals.

(Source: imgflip)

But while the market often doesn’t make sense in the short term, over the long term, as Ben Graham said, the market is a weighing machine that always correctly “weighs the substance of a company.”

My Retirement Portfolio EPD Limit Orders

Stock

Current Price

Current Yield

Target Yield

Limit Price

Distance to Limit Price

Annual Dividend

Units To Buy

EPD

$23.38

7.61%

6.8%

$26.18

-10.7%

1.78

21

6.9%

$25.80

-9.4%

22

7.0%

$25.43

-8.1%

23

7.1%

$25.07

-6.7%

24

7.2%

$24.72

-5.4%

25

7.3%

$24.38

-4.1%

26

7.4%

$24.05

-2.8%

27

7.5%

$23.73

-1.5%

28

7.6%

$23.42

-0.2%

29

7.7%

$23.12

1.1%

30

7.8%

$22.82

2.5%

31

7.9%

$22.53

3.8%

32

8.0%

$22.25

5.1%

33

8.1%

$21.98

6.4%

34

8.2%

$21.71

7.7%

35

8.3%

$21.45

9.0%

36

8.4%

$21.19

10.3%

37

8.5%

$20.94

11.6%

38

(Source: DK yield-based limit calculator) bolded = filled

This is why I’m chasing EPD to the bottom during this market pullback. I don’t care about technical analysis or how ugly EPD’s chart might look. I run my portfolio and all DK model portfolios based on the motto of “quality first, valuation second and prudent risk management always.”

(Source: imgflip)

The forward price/operating cash flow of 7.6 is the lowest since 2011. The only time EPD has been more undervalued was during the late tech bubble value stock crash and the Great Recession, as you can see by its historical yields.

(Source: Ycharts)

The Last Time EPD Was This Irrationally Valued

(Source: F.A.S.T Graphs, FactSet Research)

During periods of such extreme undervaluations conservative income investors can lock in sensational yields and strong long-term returns.

Even accounting for its worst bear market in history, buying during the Great Recession would have resulted in nearly 13% CAGR total returns over the past 12 years.

The Last Time EPD Traded At Today’s Blended Price/Operating Cash Flow

(Source: F.A.S.T Graphs, FactSet Research)

During the past 20 years, anyone who bought EPD at 8 times blended P/OCF in 2000 would have multiplied their money 10 fold and enjoyed 12.2% CAGR total returns.

(Source: F.A.S.T Graphs, FactSet Research)

In fact, during the past 20 years, EPD has recouped an investor’s initial investment five times through steadily rising distributions. It’s also beaten the market by 2.5 fold.

EPD Total Returns Since 1999

(Source: Portfolio Visualizer) portfolio 1 = EPD

Since its IPO, EPD has crushed the market, all while delivering slightly less volatility (standard deviation) than the average dividend aristocrat (21% vs 22% annual volatility). It’s long-term beta is just 0.32, showing the energy utility nature of its business model.

EPD is a perfect example of how stacking alpha factors together can result in exponential income growth and strong returns.

  • Size ($52 billion market cap vs $128 billion S&P average)

  • Value (38% undervalued)

  • Low volatility (historical beta 0.32)

  • Dividend growth

  • Quality (11/11 quality Super SWAN, wide moat)

So let me walk you through the three reasons that EPD at a 7.5% yield is not just a reasonable buy but, in the words of Chuck Carnevale, a potential “buying opportunities of a lifetime.”

Reason 1: The Safest Payout In The Industry From This Future Dividend Champion And 11/11 Quality Super SWAN

I have zero interest in value/yield traps. Reaching for dangerous yield is a mistake, while maximizing safe yield over time is a prudent long-term strategy.

So let me walk you through why I rate EPD an 11/11 quality Super SWAN.

I always begin with payout safety, since an unsafe dividend/distribution isn’t worth owning.

Why EPD Has 5/5 Distribution Safety

Metric

EPD

Safe Level

Median Peer

Distributable Cash Flow Coverage Ratio

1.7 (59% DCF payout ratio)

83% or less

1.4 (71% DCF Payout Ratio)

cash flow stability/ trend

positive 20 consecutive years, 8.2% CAGR growth over 20 years

positive and growth most years

NA

payout track record

21 annual years of distribution growth

stable or growing most years

NA

Debt/Capital

52%

60% or less

53%

Debt/EBITDA

3.5

5.0 or less

4.5

Interest Coverage

4.7

2.5+

NA

S&P Credit Rating

BBB+

BBB- or better

NA

(Sources: F.A.S.T Graphs, FactSet Research, S&P, Gurufocus, earnings release, Alerian)

EPD has raised its payout 62 consecutive quarters (15.5 years) and on an annual basis for 21 consecutive years. In 2024 it becomes a dividend champion when its payout growth streak reaches 25 years.

(Source: investor presentation)

86% of EPD’s cash flow is fee based and nearly all of that is under long-term contracts with minimum volume commitments from investment-grade energy producers.

77% of projects scheduled to be completed by 2023 are under long-term contract with investment-grade energy companies. 47% of volumes are contracted to A rated energy companies like Exxon (XOM) and Chevron (CVX).

(Source: investor presentation)

70% of the contracts signed before a penny gets spent on a new growth project are for 10 years-plus. NGL projects have 100% volume commitments for 15 years before a shovel goes into the ground.

In 2019 EPD’s DCF payout ratio was 59% which is far below the 83% safe leverage (1.2 coverage ratio) needed for self-funding midstream operators.

EPD is tied with other blue chip midstream names for the highest credit rating in the industry (BBB+).

(Source: S&P)

That means about a 5% chance of defaulting on its bonds over the next 30 years.

(Source: investor presentation)

99% of EPD’s debt is fixed rate and half of it is in the form of 30 year bonds. Yet despite steadily extending its duration to an impressive 20 years (locking in profitability on new projects), EPD’s debt costs have steadily fallen over the last decade.

“On Jan. 6, we priced an aggregate $3 billion of senior unsecured notes, comprised of $1 billion of tenure notes at 2.8% coupon, $1 billion of 31-year notes at 3.7% and $1 billion of 40-year notes at 3.95%.” – Randall Fowler, co-CEO

Anyone worried about institutions cutting off the energy industry from cheap capital can rest easy. EPD just sold 40 year bonds at under 4%, which is lower than its average 4.5% interest cost at double the maturity.

Environmentalists might not be fans of EPD, but the bond market still loves this Super SWAN.

Such is the power of the best balance sheet in the industry. Thanks to that BBB+ rating EPD has $4.9 billion in low cost liquidity to add to its nearly $3 billion in annual retained cash flow.

That’s firepower it can use for further growth or merely to repurchase stock opportunistically when the market freaks out as it’s doing now.

(Source: Alerian)

Gone are the days of midstream operators funding growth with dangerous amounts of debt or stock. Today self funding is the gold standard and pay out based on the industry’s average coverage ratio has steadily climbed from 1.0 in 2015 to 1.4 today. The new goal for most big midstream stocks is complete FCF self funding.

In 2019 EPD retained $2.7 billion in cash flow after paying its distribution. That’s a 24% increase from 2018, which was a record year for retained cash flow.

With 2020’s 6% growth consensus, EPD should retain about $2.9 billion this year. $3 billion in annual retained cash flow is sufficient to repurchase 5.5% of the stock each year. That’s the organic growth potential of EPD even if all future growth opportunities dry up.

EPD sees ongoing opportunities to put shareholder capital to work at strong rates of return (12%-plus returns on capital). In 2019 EPD’s return on capital was 13.2%, better than 75% of its peers, and above the 13-year median of 12.5%.

(Source: investor presentation)

EPD’s total spending plans for 2021 are about $3 billion, including maintenance capex. That’s compared to about $3.1 billion in retained cash flow that analysts currently expect, per FactSet consensus.

Or to put another way, in 2021 EPD might be the fourth midstream operator that’s not just self-funding from an equity perspective (no new stock needed to fund growth), but FCF self-funding.

FCF self-funding midstream stocks (2021 guidance)

Equity self funding is the gold standard of safety for this industry. FCF self funding is the platinum standard. It means a midstream operator has zero need for new debt or equity to fund its growth while paying its distribution/dividend.

(Source: S&P)

S&P expects ever safer amounts of self funding to result in steadily falling leverage ratios across the industry, steadily rising interest coverage and a focus on returning capital to investors via buybacks and modest payout growth.

We assume that midstream credit measures will modestly improve, depending on the use of excess cash flow. We forecast that investment-grade midstream companies will achieve average debt EBITDA of about 4.2x, while their speculative-grade peers will have a debt-to-EBITDA ratio closer to 4.75x in 2020.” – S&P Global (emphasis added)

EPD’s leverage ratio of 3.5 already is one of the lowest in the industry and set to fall steadily over time, potentially earning it the first A rating of any midstream operator.

So that’s why EPD gets a 5/5 safety rating. The reason for its 3/3 business model rating is the wide moat nature of its asset base which is what allows it to maintain industry-leading profitability over time.

(Source: investor presentation)

EPD has spent decades building one of America’s most vertically-integrated midstream networks. On average a molecule of oil or gas passes through six of EPD’s assets from well to end consumer, earning EPD a fee each time.

In 2019 it had a record growth year completing $5.4 billion in growth projects. As importantly, according to co-CEO Jim Teague: “All of 2019s major projects were completed on time and on budget.”

I’m hardly the only one who considers EPD’s assets best in class. Here’s Morningstar’s Stephen Ellis explaining why his firm has a “wide moat-stable outlook” rating on Enterprise.

“While many other midstream operators are playing checkers, Enterprise Products Partners is a chess master. It is the pre-eminent midstream infrastructure company, vertically integrated with best-in-class assets at nearly every point in the midstream value chain. It can aggregate supply of every type of hydrocarbon from multiple sources in major producing basins (Permian, Eagle Ford, DJ, Piceance, Green River) and deliver it to multiple end markets (refiners, petrochemicals, exports). These assets are the linchpins for both shippers and end users.” – Morningstar (emphasis added)

(Source: Ycharts)

EPD’s profitability is relatively stable over time. It’s also among the best in the industry, confirming its wide and stable moat

  • Operating margin in 72nd industry percentile

  • Return on equity in 87th industry percentile

  • Return on assets in 85th industry percentile

  • Return on capital in 75th industry percentile

Finally there’s management quality/dividend friendly corporate culture. I base this score on management’s ability to adapt to challenges and maintain above-average or excellent profitability over time. I also base it on the dividend track record and how conservative management is with the balance sheet.

(Source: investor presentation)

EPD has long been considered by many analysts to be No. 1 in management quality and corporate governance. Management’s interests are very aligned with unit holders, because it owns 32% of the MLP (via EPCO).

We ascribe an Exemplary stewardship rating to 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.” – Morningstar

Jim Teague became CEO in 2016, after serving as COO for six years. He has more than 40 years of experience in the energy/petrochemical industry. In 2020 EPD shifted to a co-CEO structure, with CFO Randy Fowler officially becoming Teague’s equal.

Frankly, all we’re doing is formalizing how we’ve always run the Company. …Randy and I don’t compete with each other. We compliment each other… We’ve been together for over 20 years. So we are friends and we respect what other brings to the table.” – Jim Teague, Q4 2019 conference call

Teague and Fowler have worked together for more than 20 years, and are considered legends in this industry.

Meanwhile Randa Williams, the chairwoman of the board and head of EPCO (EPD’s GP), backs this MLP with more than $100 million per year in distribution reinvestments. By taking her payments in stock that frees up more cash flow for the best management team in the industry to put to work growing unitholder wealth.

EPD was the second MLP in America to eliminate IDRs (in 2010) and management has consistently been a buyer of its stock on the open market.

(Source: OpenInsider)

In just the last three weeks, Chairwoman Randa Duncan (the daughter of the founder of EPD) has bought 858,000 units for more than $21 million. CEO Jim Teague recently bought 20,000 units for more than $500,000.

Note that The Duncans own more than 700 million units (worth $16 billion) and Jim Teague almost 2 million (worth $43 million). The best management team in the industry is definitely eating its own cooking.

(Source: investor presentation)

What about the fear that many investors have the EPD might “check the box” and convert to a C-Corp?

Randy Fowler told analysts at the Wells Fargo Energy Symposium that “There may be an element of inevitability… K-1 island is becoming very exotic.”

However, Hinds Howard, a portfolio manager at CBRE Clarion Securities LLC and Seeking Alpha midstream guru, explains that EPD isn’t likely to covert this year.

The idea is that at some point, if they are the only ones left, they would prefer not to be… “But general speculation is that they would wait to see how the election goes before making the permanent change to their tax status.”

The one time tax hit resulting from a corporate conversion (on deferred distributions) would most affect management who owns more than $16 billion worth of the stock.

What might happen instead is that EPD could potentially spin off corporate shares as Energy Transfer (ET) is planning to do this year. This would be like what Brookfield has done with BPR, and is planning on doing with BIPC and BEPC this year.

Investors who own EPD now could end up with a stock split, owning corporate shares that pay qualified dividends as well as their current unit. The payout itself would be reduced by the proportional amount, but there would be no change in the value of your holdings or your annual income.

Does a potential corporate conversion matter to long-term investors? Absolutely not. It will have no affect on EPD’s self-funding growth plans, nor will it in any way threaten its ability to become a dividend champion in 2024.

Basically, EPD is a 5/5 safety, 3/3 business model and 3/3 management quality/corporate culture stock. A 11/11 quality Super SWAN that high-yield investors can rely on to provide generous, safe and growing income in all industry, economic and market conditions.

But quality isn’t enough to recommend a company much less buy it for my portfolio so aggressively. I need a good long-term growth outlook, which EPD most certainly has.

Reason 2: 2 Long-Term Growth Catalysts

Given its stock price action, you might think that EPD was a dying company. After all, a 7.6 forward price/cash flow means the market is pricing in -2% CAGR long-term growth per the Graham/Dodd fair value formula.

Let me assure you that EPD is NOT a “value trap.”

EPD Growth Profile

Metric

2020 Growth Consensus

2021 Growth Consensus

2022 Growth Consensus

Distribution

2%

2%

2%

Operating Cash Flow/share

6%

3%

NA

EBITDA/share

11%

4%

4%

EBIT/share

14%

4%

3%

(Source: F.A.S.T Graphs, FactSet)

“We ended the decade with record performance in 2019 with all of our business segments reporting increased results, including 28 operating and financial records.” – CEO Jim Teague, earnings press release

Its growth rate will be slower than in the past, but it’s expected to grow at a utility like rate.

EPD has two forms of organic growth potential right now.

In 2019 EPD grew cash flow per unit by 4% courtesy of putting $5.4 billion worth of growth projects into service.

Enterprise also intends to use approximately 2 percent of its 2020 CFFO to buy back its common units during 2020. Using 2019 CFFO as a base, these proposed distribution increases and unit buyback plan would result in an approximate 5.6 percent increase in capital returned to limited partners in 2020 compared to 2019.” – EPD earnings release

EPD converts 80.5% of its cash flow into DCF, which is among the best in the industry. With a 7.6 cash flow multiple right now that means buying back its stock would generate a DCF yield of about 10.5%.

“If we are successful in retaining our spread income in 2020 at 2019 levels and if free cash flow was higher, one of the things that we can also consider again, the potential for higher buybacks.” – Randall Fowler, co-CEO, Q4 CC

EPD plans to repurchase about $500 million in stock in 2020, 10 times what it bought back in 2019. And that figure might end up a lot higher given how low the unit price is trading right now.

“Using debt to fund part of Enterprise’s 2020 capital spending plans would mean about $1 billion in excess cash would be available for buybacks in 2020.” – Morningstar’s Stephen Ellis

Buying back stock is basically as profitable as building new growth projects earnings 13% returns on capital. The reason EPD can’t shut down all construction is that its projects are contracted for. Stopping construction would harm its customers, and hurt it reputation.

Or to put another way, the very reason that Wall Street is so worried about midstream (lower future energy growth rates) can be offset by stock buybacks that keep growth rates stable and around 3% to 5% for most midstream operators.

US oil production is expected to slow down and peak in about 2025.

(Source: EIA)

Gas production is expected to keep growing steadily (and natural gas liquids alongside it) through at least 2050. That’s based on the growing demand for LNG in emerging economies like China, India, Asia, and Latin America.

(Source: Investor presentation, IEA)

The US Energy Information Administration is hardly the only one bullish on long-term US energy. The International Energy Agency also expects emerging market demand to drive slowing but ongoing growth in oil and gas liquid demand through at least 2040.

(Source: investor presentation)

That’s why EPD is investing $7.7 billion for projects that will be online in 2023 or earlier. 60% of that spending is to support the petrochemical industry, 30% crude production and just 10% natural gas (which is suffering the most right now).

(Source: investor presentation)

OPEC also expects roughly the same thing, with no peaking in oil and liquids demand for another 20 years.

(Source: BP)

In case you don’t trust those three sources, here are all the various global oil demand models through 2040. Note that BP is being very conservative, and modeling just 3% legacy volume declines per year. The IEA estimates oil fields decline by 6%, on average, globally.

Yet even assuming half that decline rate (as BP does) there’s no scenario in which new oil production doesn’t have to rise significantly in order to meet demand over the next two decades.

The point is that the current hyper-pessimism seen in the energy space is almost certain to be a major overreaction. Thus the reason quality safe midstream giants like EPD are the buying opportunity of a lifetime during this correction.

Reason 3: Anti-Bubble Valuation Despite The Best Fundamentals In Its History = 12% To 20% CAGR Long-Term Total Return Potential

The way I value a company is by using a historical approach that either:

  • Applies the company’s own historical multiples for periods of similar industry fundamentals (regulatory regimes, interest rates, etc) and growth rates.

  • Applies the Graham/Dodd fair value formula to companies expected to grow at slower than their historical rates (or historical multiples if they are lower)

So let me walk you through my valuation model for Enterprise.

EPD Growth Profile

  • FactSet long-term growth consensus: 2.1% CAGR

  • FactSet growth consensus through 2021: 5.0% CAGR

  • Reuters’ five-year growth consensus: 8.0% CAGR

  • YCharts long-term growth consensus: 5.0% CAGR

  • Morningstar long-term growth forecast: 4% CAGR

  • Historical growth rate: 8.2% CAGR over 20 years, -7% CAGR to 14% CAGR rolling growth rates

  • Realistic growth range: 2% to 6% CAGR

  • Historical fair value: 11 to 13 times operating cash flow

I build a growth range for each company factoring in all the consensus growth forecasts, management guidance, industry trends, and how often a company meets, beats or misses 12 and 24-month forecasts.

Enterprise’s track record on meeting expectations is very good, especially for an energy stock. Most midstreams have stable and relatively predictable cash flows and thus 70% to 80% meet/beat rates. EPD’s record is above average for 12-month forecasts, and for two-year forecasts, it’s 100% within a 20% margin of error.

Overall, I expect 2% to 6% CAGR long-term cash flow growth from EPD, which is slower than its historical growth rate. To model it I look at the slowest growth period it’s had in the past 20 years, which is the eight-year F.A.S.T Graphs tab (last six years and two years of consensus forecasts), during which it grew at 5.7% CAGR.

Note that this time period is virtually entirely within the worst industry bear market in history, and thus relatively conservative.

EPD Valuation Matrix

Metric

Historical Fair Value (8 Year)

2020

2021

2022

5-Year Average Yield

6.10%

$29

$30

$30

Operating Cash Flow

12.8

$40

$42

NA

EBITDA

10.6

$40

$42

$43

EBIT

15.5

$44

$46

$47

Average

$38

$40

$40

(Sources: F.A.S.T Graphs, FactSet Research, Reuters’, Gurufocus, YieldChart)

Normally I’d include the 13-year and 25-year (or since IPO) yield based fair value estimates as well. However, since the midstream industry has drastically shifted its business model since 2015 (for the better) I’m only using the five-year time frame to represent dividend yield theory.

This gives a low-ball fair value estimate since EPD has been in a bear market for the past half decade.

Using just the five-year yield timeframe results in a far more conservative fair value estimate than the long-term time frames as well as the lowest estimate of the four appropriate industry metrics I use.

EPD’s intrinsic value likely lies between $29 and $44, with the average of $38 representing a reasonable approximation of what its fundamentals are worth in 2020.

I then apply margin of safety requirements based on the quality of a company to determine when it goes from being merely a potentially reasonable buy to a good buy or better.

Quality Score (Out of 11)

Example

Good Buy Discount To Fair Value

Strong Buy Discount

Very Strong Buy Discount

Ultra-Value (Anti-Bubble) Buy Discount

7 (average quality)

AT&T (T), Meredith Corp (MDP), Innovative Industrial Properties (IIPR)

25%

35%

45%

55%

8 above-average quality

Walgreens (WBA), CVS Health Corp. (CVS), ViacomCBS (VIAC)

20%

30%

40%

50%

9 blue-chip quality

Altria (MO), AbbVie (ABBV)

15%

25%

35%

45%

10 SWAN (sleep well at night) quality

PepsiCo (PEP), Dominion Energy (D)

10%

20%

30%

40%

11 (Super SWAN) – as close to a perfect dividend stock as exists on Wall Street

3M (MMM), Johnson & Johnson (JNJ), Caterpillar (CAT), Microsoft (MSFT), Lowe’s Companies (LOW), Enterprise Products Partners (EPD)

5%

15%

25%

35%

By definition, it’s always theoretically reasonable to pay fair value for a company. That’s if its other fundamentals (like yield, growth prospects, return potential) meet your needs.

Classification

Margin Of Safety Required For 11/11 Super SWAN Quality Companies

2020 Price

Reasonable Buy

0%

$38

Good Buy

5%

$36

Strong Buy

15%

$32

Very Strong Buy

25%

$29

Ultra Value Buy

35%

$25

Currently

38%

$23.85

Today I consider EPD an ultra value buy. What does that mean? That a company is in an “anti-bubble.”

According to Research Affiliates, an anti-bubble is:

An asset that requires implausibly pessimistic assumptions in order to fail to deliver a solid risk premium.”

Or to put another way the margin of safety is so high that barring a complete collapse of the business model, buying today, represents, in the words of Chuck Carnevale “the buying opportunity of a lifetime.”

If EPD grows at zero forever, then it would be worth 8.5 times operating cash flow per the Graham/Dodd fair value formula.

(Source: F.A.S.T Graphs, FactSet Research)

Even if EPD never grows again, investors could expect about 7% CAGR long-term returns, purely from the very safe yield.

Note that F.A.S.T Graphs uses the blended P/OCF which is currently almost entirely based on 2019’s operating cash flow/unit. On a forward basis (2020 consensus) here’s how EPD’s reward/risk profile looks

  • Forward price/operating cash flow: 7.6

  • Forward operating cash flow yield: 13.2% (vs 6.7% “reasonable” per Graham/Dodd fair value formula)

  • 10-year US Treasury yield: 1.3%

  • Operating cash flow yield risk-premium: 11.9% vs 3.7% S&P 500 average since 2000

  • Reward/Risk Ratio: 3.2X S&P 500 historical norm

EPD is objectively one of the highest quality income investments on earth. Yet its reward/risk ratio is more than three times the market’s historical norm.

How undervalued is EPD right now?

Private equity firms, who buy private companies with plans to improve/fix them over five to 10 years and then flip them for a profit/take them public, are paying about 12 times cash flow.

During its first 10 years, the average Shark Tank deal was at a multiple of 7.0 times earnings/cash flow.

EPD at 7.6 times cash flow is literally trading near Shark Tank multiples and at the low end of private equity valuations. But EPD is not some struggling turnaround story, but a thriving and growing large-cap blue chip, and a future dividend champion.

It’s also 100% liquid, meaning you can convert units to cash at any time, with a tiny spread.

Basically, EPD at 7.6 times cash flow makes absolutely no fundamental sense, and thus its status as the most undervalued Super SWAN and an “ultra value” buy.

What kind of returns can you realistically expect buying EPD at today’s absurdly low price and a very safe 7.5% yield?

To create the long-term total return potential range I apply the historical fair value range to the realistic growth range.

(Source: F.A.S.T Graphs, FactSet Research)

If EPD grows at just 2% CAGR over time, as FactSet expects, then the Graham/Dodd fair value formula estimates it would be worth 12.5 times operating cash flow. That’s nearly identical to its six-year average of 12.8 that I use in my valuation model.

But for the conservative end of my total return model, I use the low end of historical fair value, 11 times OCF. Even with those conservative assumptions, EPD can realistically double your investment over the next five years.

Compare that 12% CAGR conservative return potential to the 3% to 6% CAGR most asset managers expect from the S&P 500 in the coming years. My market return model estimates about 6% CAGR total returns over the next five to 10 years, the same as BlackRock’s.

EPD’s conservative return potential is double the broader markets. That’s the power of a Super SWAN quality high-yield stock trading at anti-bubble valuations.

(Source: F.A.S.T Graphs, FactSet Research)

If EPD beats expectations (YCharts), grows at the upper end of its growth potential, and trades at the upper end of historical fair value, then it could nearly triple your investment over the next five years.

(Source: imgflip)

The ability to earn a safe 7.5% yield from a Super SWAN quality future dividend champion that can deliver 12% to 20% CAGR long-term returns is why EPD is one of my highest conviction ideas right now.

However, no investment is right for everyone and before you buy any stock you must first consider it’s risk profile.

Risks To Consider (Why EPD Isn’t Right For Everyone)

Based on how MLPS like EPD have been crashing recently you might think that they are at high risk of low oil prices.

Our base-case price assumptions for West Texas Intermediate and Brent crude oil is $60 per barrel and $55/bbl, respectively, for 2020. We then have Brent decreasing to $55/bbl for 2020 and beyond, which is in line with our assumptions for WTI. Our price assumption for natural gas is $2.50 per million British thermal unit (mmBtu) in 2020, $2.75/mmBtu in 2021, and $3.00/mmBtu in 2022 and beyond. We are forecasting that natural gas liquid prices average about 50 cents per gallon. Under these price assumptions, we don’t expect commodity prices to substantially change our forecast assumptions or harm midstream companies’ credit profiles because most already have largely fee-based contract profiles.” – S&P Global

In reality, the big midstream names that populate the “safe midstream/MLP list” have 15% or less commodity price-sensitive cash flows.

We expect U.S. E&P companies to scale back production, which has been factored into our midstream growth forecasts. We believe companies with exposure to the Permian Basin and Bakken Shale regions will perform the strongest in 2020, while companies with exposure to areas of the SCOOP/STACK basin and Marcellus and Utica Shales may somewhat underperform based on our revised forecasts.” – S&P Global

However, it’s true that lower oil and gas prices will mean falling growth capex from upstream names (midstream customers).

That’s why S&P and other analysts expect midstream growth capex to keep falling over the next few years, as they focus more on FCF self funding, deleveraging and repurchasing their incredibly undervalued stock.

In terms of fundamental risks, S&P points out three things midstream investors need to pay attention to.

The first is regulatory risk. Environmentalists will continue attempting to block major pipeline projects, such as the Atlantic Coast Pipeline (overseen by Dominion Energy) and EQT Midstream’s (EQM) Mountain Valley Pipeline.

EPD focuses on lower-regulatory risk projects in friendly jurisdictions like Texas. That’s why 100% of its projects in 2019 came in on time and on budget.

What about the risk of a fracking ban as Bernie Sanders has proposed? That’s always a possibility, however, currently a low probability risk, since he’s merely favored, but not likely to win the Democratic nomination on the first ballot.

(Source: Fivethirtyeight.com)

As things stand now, it appears the most likely outcome (after all states have voted) is a contested convention.

Even if Sanders gets the nomination he would still need to win the general, which means winning the six swing states that will likely decide who wins the White House in 2020.

(Source: 270towin.com)

As things look now there are 13 ways the swing states could break. Seven of those are outright wins for the Democrat, four for Trump and two a tie. In an electoral college tie, the incoming House would select the president with each state getting one vote.

26/50 state delegations are controlled by Republicans and this is not expected to change in 2020. Thus a tie in the electoral college is likely a de-facto win for Trump. It also means that based on the best consensus forecasts we have now, the current combination of likely swing states favors Democrats 54/46.

That’s a statistical tie, especially given the limited state head to head polls we have available so far. These have a 5% margin of error, so anything less than a 6%-plus lead by any candidate is effectively a tie.

(Source: Real Clear Politics)

Trump and Sanders are statistically tied in every swing state.

In late January 2020, Sanders introduced a bill to ban fracking in the Senate. The prospects of such a ban could potentially cause midstream to remain weak for much of 2020.

(Source: Quote Fancy)

Here’s what investors need to know about a president’s ability to ban fracking. From CNN’s FactCheck:

Facts First: Without an act of Congress, the president could not issue an outright ban on fracking across the US. There are however a number of regulatory and executive actions an administration could take to prevent or shrink the use of fracking technology, particularly on federal land. The problem is that most fracking takes place on private land, and any attempts to limit it would likely face legal challenges.

(Source: 270towin.com)

Democrats are expected to lose nine seats this year and to retain a slim majority.

According to the Bureau of Labor Statistics, more than 470,000 people worked in oil and gas production in 2018, bringing in wages of more than $54 billion. The chances that House members from Texas, New Mexico, Colorado or other major energy states would sign onto a national fracking ban are remote.

(Source: 270towin.com)

Anything that passes the House must pass the Senate. Currently, there are four toss up races and Democrats must win all of them (including in Alabama) in order to control the Senate.

It’s possible that Sanders being the nominee could cost Democrats one or two critical Senate races that result in a divided government and thus little chance of any major regulatory reforms occurring.

Dividend government and a lack of a filibuster proof majority in the Senate (60 votes) is why both Morningstar and Moody’s estimate the probability of major reforms (like banning fracking) at 5% or less over the next 10 years.

Sound investing is about taking calculated risks that you are well compensated for with a high margin of safety. A 5% or less risk of major disruption of their business models is why I don’t lose sleep despite having 20% of my retirement portfolio in midstream.

However, I do recommend capping all sectors at 25% or less just in case the worst-case scenario does occur.

Sustained low gas prices, heavy debt burdens, high-cost structures, and other contractual obligations have hurt many U.S. E&P companies’ credit quality. We took several negative rating actions on upstream issuers that focus on the Marcellus and Utica Shales, including Antero Resources, EQT Corp, CNX Resources, and Range Resources.” – S&P Global

Counterparty risk is something the market is currently obsessing over, with fears of bankrupt oil and gas producers breaking minimum-volume committed contracts one of the major reasons EPD and most midstreams are so undervalued right now.

The MLP’s massively diversified customer base, including mostly investment-grade counter-parties, means that EPD investors can sleep soundly at night. Your payouts are safe and likely to keep growing as they have for the last 21 consecutive years.

Valuation risk is very low, with EPD trading at the lowest valuation in nine years. But volatility risk is something that even ultra-value Super SWANs must contend with.

(Source: Ycharts)

EPD’s long-term volatility is 20.2%. That’s roughly the amount investors can expect it to fall in any given year. That’s actually lower than dividend aristrocrats (22% volatility).

However, in any given downturn, long-term statistics can give way to irrational market panic. EPD has outperformed energy stocks and most MLPs this year. But only buy falling less.

EPD Max Declines Since 1999

(Source: Portfolio Visualizer) portfolio 1 = EPD

During the tech crash and Great Recession EPD was defensive, outperforming the broader market. But it has yet to recover from its longest and most severe bear market in history, which is now in its sixth year.

As Chuck Carnevale frequently points out to our members, value investing is a game of patience, discipline and waiting long enough for your companies to prove, in the words of Warren Buffett, “your facts and reasoning right.”

(Source: Larry Swedroe) profitability = quality, beta = low volatility

How long can proven alpha factors underperform? 10 years or more, as seen with value stocks over the past 12 years. Here’s a table showing how often alpha factor strategies have underperformed for an entire decade.

About one decade in six value stocks underperform for 10 or more years at a stretch. Quality, meaning high returns on capital, underperform for up to five years 15% of the time.

Only because factor strategies never work all of the time, do they continue to work over the long term. Diversifying your portfolio by targeting numerous strategies, ie “alpha,” is what I recommend and do in my portfolio.

For example, EPD stacks five factors on top of each other, value, size, dividend growth, low volatility and quality.

Bottom Line: EPD’s Latest Crash Is The Buying Opportunity Of A Lifetime For Patient High-Yield Investors

When will EPD’s bear market end? I have no idea. I’m not a market timer, and don’t care a lick about technical indicators and how pretty or ugly a chart looks.

Eventually the only thing that matters is fundamentals, meaning dividends, earnings and cash flow. That’s about as close to the gospel truth as you’ll find on Wall Street.

EPD’s fundamentals have remained not just resilient over the past six years, but steadily improved. That includes not just steadily rising cash flow but distributions that have grown for 62 consecutive quarters and 21 years.

(Source: AZ Quotes)

At 38% undervalued, Super SWAN and future dividend champion Enterprise Products Partners represents the safest 7.5% yield I know of.

It’s not just a reasonable or good buy, it’s a down-right ultra-value anti-bubble stock that is likely could deliver 12% to 20% CAGR long-term returns as you collect that fantastic yield.

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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2020 marks our 3rd year of REIT bracketology in which we will break down all REIT property sectors in order to determine the best companies to own. Our highly skilled analysts will provide play-by-play coaching so you will not foul out and you can obtain the most predictable results.

Act Now so you can get your front row seat before tipoff! We want to make sure your winning team makes it to the Final Four and hopefully puts you in the winner’s bracket.

Disclosure: I am/we are long EPD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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