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Both Plains All American (NASDAQ:PAA)(NASDAQ:PAGP) and Enterprise Products Partners (NYSE:EPD) are investment grade midstream master limited partnerships that sport sky-high forward distribution yields of 8.6% and 7.6%, respectively.
In this article, we will review their Q3 results and then compare them side by side and offer our take on which one is a better buy.
Enterprise Products Vs. Plains: Q3 Results
Both businesses generated strong results in Q3 in terms of business fundamentals, balance sheet strengthening, and unitholder capital returns.
PAA raised full-year adjusted EBITDA guidance by an additional 3.2%, representing 11.4% upside to the initial full-year guidance provided back in February. Most importantly, PAA achieved their target leverage ratio during Q3 and anticipates remaining below it moving forward, enabling them to announce a new capital allocation framework that is expected to result in significant distribution growth in the quarters and years to come.
This is consistent with what PAA’s CEO said on the Q2 earnings call:
I think you’ll see that we will continue to support distribution increases.
EPD, meanwhile, reported similarly strong results, with distributable cash flow rising 16% year-over-year on the strength of transporting record volumes (11.3M bbl/day) through its pipelines in Q3. Furthermore, its natural gas pipelines transported 17.5T Btus/day (also a record) in Q3 while also setting quarterly records for NGL fractionation, ethane export, butane isomerization and fee-based natural gas processing volumes.
In good news for both businesses – particularly PAA – both businesses cited strong production growth momentum in the Permian Basin moving forward.
Enterprise Products Vs. Plains: Business Model
PAA’s business model is focused on maximizing its competitive positioning in the Permian Basin (where it generates ~80% of its adjusted EBITDA) while also owning some complementary Western Canadian NGL assets. However, it is also focused on crude and refined products, with only 20% of its EBITDA coming from NGL. As a result, it lacks the energy commodity diversification that many other midstream businesses benefit from.
EPD’s business model is both larger and much more diversified than PAA’s, giving it more avenues for growth and also reducing downside risk in the event that a particular geography and/or energy commodity were to experience outsized headwinds. EPD profits from virtually every category across the midstream value chain and has generated some of the most consistently strong results and returns on invested capital in the entire sector.
Both businesses enjoy pretty stable cash flow profiles, especially compared to upstream energy explorers and producers, given the long-term fixed-fee take-or-pay nature of most of their pipeline contracts. Overall, both have relatively little exposure to commodity price fluctuations.
We give EPD the edge here, given its vastly superior track record for generating attractive returns on invested capital and its greater scale and diversification.
Enterprise Products Vs. Plains: Balance Sheet
EPD has arguably the strongest balance sheet in the entire midstream sector with an industry-leading BBB+ (stable outlook) credit rating, a meager 3.1x leverage ratio (which is below the low end of its target leverage ratio range of 3.25x-3.75x), a whopping $3.3 billion in consolidated liquidity, and weighted average term to maturity on its debt of 20 years.
EPD is also poised to generate sufficient free cash flow after distributions and growth capital expenditures moving forward to fully retire near-term maturities when combined with its current liquidity. As a result, there is little to no concern about EPD’s financial strength and ability to respond opportunistically to market dislocations. As the CEO said on the Q3 earnings call:
Thinking back on my career, first with Dow and here at Enterprise, I can’t count the number of downturns I’ve been through. At Dow, the downturns were always painful, but here at Enterprise they always bring opportunity. In the current environment, while the uncertainties are real, the certainty that Enterprise will always deliver is real too.
While unable to match EPD’s financial heft, PAA has a strong investment grade balance sheet of its own with aspirations to continue improving it moving forward. The partnership reduced its leverage ratio during the quarter to 3.7x and anticipate it remaining around 3.8x at year-end and declining moving forward. As management said on the Q3 earnings call:
We anticipate leverage migrating below the low end of our targeted range of 3.75 to 4.25x in 2023. And consistent with our objective in achieving and maintaining our mid-BBB and equivalent credit ratings.
PAA also has significant liquidity of $3.3 billion, including $600 million of cash on the balance sheet. Similar to EPD, PAA’s goal in 2023 will be to fully retire maturing debt using a combination of existing liquidity and retained free cash flow net of distributions and growth capital expenditures. This will lead to further natural de-leveraging, while also preventing them from having to tap debt markets while interest rates are so high.
Both businesses are in very strong financial shape at the moment, given that they are self-funding and not reliant at all on the debt or equity markets for the foreseeable future. However, EPD retains the edge here by virtue of its superior credit rating (EPD’s BBB+ compared to PAA’s BBB-).
Enterprise Products Vs. Plains: Distribution Outlook
While EPD is about to hit a quarter century of consecutive distribution growth and also boasts a phenomenal distribution coverage ratio of 1.8x, we favor PAA’s distribution outlook right now. EPD’s management hinted at continued mid-single-digit distribution growth moving forward, stating on the earnings call:
2022 marks our 24th year in a row for distribution growth, and we think next year, it’ll be 25 years in distribution growth… in talking to a lot of investors given the inflationary environment they’re in, they really appreciate the 5.6% distribution growth year-over-year. That’s helpful to a lot of our individual unitholders.
While this is definitely a satisfactory distribution growth rate given EPD’s low risk profile and high current distribution yield, PAA’s distribution growth profile is vastly superior. Management announced along with the Q3 report that:
Management currently intends to recommend to the Board of Directors of PAA GP Holdings LLC (“the Plains Board”) an annualized increase of $0.20 to PAA’s and PAGP’s fourth-quarter 2022 distribution payable in February 2023 (one quarter earlier than our standard beginning-of-the-year annual budgeting process), which would increase the annualized rate from $0.87 to $1.07 per common unit and Class A share. Beyond 2023, as part of its standard annual review process, management anticipates targeting annualized common distribution increases of approximately $0.15 per unit each year until reaching a targeted Common Unit Distribution Coverage Ratio of approximately 160%
This would be a 23% increase from the current annualized payout with mid-teens growth rates in the years following. PAA is expected to generate $2.42 in DCF per unit in 2023, $2.56 in DCF per unit in 2024, $2.78 in DCF per unit in 2025, and $2.83 in DCF per unit in 2026, good for a 6.3% CAGR over that span. If PAA follows through with its capital allocation framework – and assuming no major unit repurchases are executed over this timeframe – its distribution per unit will have reached $1.52 in 2026 and the distribution coverage ratio will still be at 186%. This means that – assuming DCF per unit grows at a 3% CAGR beyond 2026 – in 2028 the distribution would be at $1.88 for the coverage ratio to finally reach 160%. That means that from now through 2028, PAA could quite possibly post a 13.7% distribution CAGR on top of the current pre-hike distribution yield of 7% (the forward yield assuming the $1.07 annualized payout goes into effect is 8.6%). This makes PAGP an incredibly attractive income investment right now, holding enormous current income and medium-term distribution growth potential for investors.
Enterprise Products Vs. Plains: Valuation
Both businesses also look attractively priced when compared to sector peers as well as their own histories. Here is a side-by-side comparison of them:
| PAA | EPD | |
| EV/EBITDA | 8.08x | 9.11x |
| EV/EBITDA (5-Yr Avg) | 9.70x | 10.68x |
| P/2023 DCF | 5.13x | 7.17x |
| Distribution Yield | 8.6% | 7.6% |
Overall, PAA looks to be the clear winner in terms of cheaper valuation, though it is noteworthy that EPD appears to be trading at a roughly similar discount to its historical average EV/EBITDA as PAA is. EPD’s track record is also vastly superior and its management, balance sheet, and asset portfolio are also considered to not only be much better than PAA’s but arguably the best in the industry. At a premium of just 1.03 turns of EBITDA to PAA, that seems like a pretty good deal. On the other hand, PAA does boast stronger DCF per unit and distribution per unit growth potential. Overall, we give a slight edge to PAA here.
Investor Takeaway
We love both and own both of these midstream businesses. In our view, EPD is the ultimate retiree income stock as it combines a very attractive current yield with very consistent distribution growth along with a low-risk profile. You can sleep well knowing that your distribution next year will be higher than this year’s and that this security can go a long way towards meeting your retirement goals. In fact, you can probably own an outsized position in it given its low-risk profile and excellent management, with 1/3 ownership of the partnership by insiders.
Meanwhile, with PAA you get one of the most compelling values in the market today with a high current distribution yield and double-digit annualized distribution growth potential for the next half decade. Meanwhile, the risk profile is a bit higher than EPD’s, but that is coming down quickly as well thanks to management’s laser-like focus on reducing debt as quickly as possible. We rate both as Buys right now and look forward to collecting the fat distribution checks from both for years to come.
Important note: EPD and PAA issue K-1 tax forms whereas PAA’s economic equivalent PAGP issues a 1099 tax form. Keep this in mind and do your own tax due diligence before investing, especially as a foreign investor or as an American citizen investing in a tax advantaged account.
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