This Midstream oil and gas stock is always a bargain – The Fool Motley

The intermediate sector is losing momentum today, with the Alerian MLP ETF still nearly 45% from the peaks of mid-2014. But you have to be careful about what you buy in this sector: Many mid-cap limited partnerships have been forced to reduce their distributions in recent years due to industry difficulties.

This, however, has not happened Enterprise Products Partners L.P. (NYSE: EPD), one of the largest mid-market companies in North America. And it is taking steps to ensure that this is never the case, creating a buying opportunity for income-oriented investors across the spectrum of risk.

Painted with the wrong brush

Intermediate companies hold the assets that transport oil, natural gas and related products to the country. The energy sector simply can not function without these pipelines, these storage facilities, these process plants and these transportation centers. As long as we continue to use these fuels and products, Enterprise and its peers have customers who can not operate without their services. In addition, there are often unique assets that can not be easily replaced – for example, there are only a very large number of locations that can support a seaport, which gives large players like the company monopoly similar positions in certain markets.

Investors were very enthusiastic about this space a few years ago, pushing the mid-cap companies' prices upwards and reducing their yields. All of this changed in mid-2014 when the oil price bubble burst. Intermediate stocks fell sharply with oil prices as the Alerian MLP fell more than 50% at some point. Median partnerships that used a lot of leverage and were forced to reduce distributions seemed to validate the sale.

Businesses have also fallen and remain at around 30% of their record prices. But he never used his excessive indebtedness, thanks to his indebtedness to EBITDA, which is at the bottom of the industry. Distributable cash flow, on the other hand, has hedged its distribution by at least 1.2 times in each of the past five years, throughout the bear market. And Enterprise continued to reward investors with the distribution increases throughout the slowdown. This mid-market business has not stalled or dropped the unitholders.

EPC price data on physical book value by YCharts

At this point, Enterprise's tangible book value is about 4.7 times, which is about the same level as many of its closest peers. The problem is that Enterprise is one of the best managed middle partnerships. It should probably trade at a multiple of valuation closer to Magellan's Intermediate partners, L.P. (NYSE: MMP), another well-managed median player with a tangible book value of nearly 7.3 times.

Although this price disparity exists, investors from all walks of life have the opportunity to obtain Enterprise's 6% high return.

Get better

The big question here, though, is what would change the investor opinion about Enterprise, so as to reduce the valuation gap between these two partnerships. The answer is now part of the valuation problem: Enterprise has made the decision to slow down distribution growth for a while so that it can fund more of its growth investment plans with internally generated cash. This is one of the big differences between Magellan and Enterprise: Enterprise has always relied more on sales of dilutive units to finance growth, while Magellan has long been interested in self-financing its expansion.

Average number of diluted shares EPD (annual) outstanding by YCharts

The general idea is that a company must find a new balance between the funds it retains and the funds distributed. Once the new equilibrium is found, investors should expect a resumption of distribution growth. Historically, Enterprise has increased its annual distribution to an average figure. As this business redesign is taking shape, the hikes will likely be less than 10%. It's a bit disappointing, but it will enhance the long-term partnership activities.

To be fair, Magellan has always increased its distribution to a higher rate (about 10% on an annualized basis over the past decade) than Enterprise, which is another reason for the price difference between the two. partnerships. However, Magellan expects only a distribution growth of 5% to 8% over the next two years. The bottom of this range is what investors should expect from Enterprise once this transition phase is over. Therefore, as Enterprise adopts a model closer to Magellan's approach, the haircut between the two should shrink, even if it does not close completely. Enterprise is simply a better than average median partnership.

A limited opportunity in time

The current problem is that Enterprise can not simply switch a switch: it has to let its series of investment spending unfold, a process that takes time. Once the assets he has created will begin to substantially increase his cash flow, he will be able to start self-financing more growth. The partnership is already making visible progress, with distribution coverage throughout the first half of 1.5 times out of a 27% increase in distributable cash flow. Enterprise is getting closer and closer to its goal as its cash cushion develops.

When it finally announces the transition of its business model, the growth of the distribution will probably be accelerated again and the stock market should reasonably reward it with a higher valuation. Which suggests that despite the slowdown in distribution growth, it is now time to add business product partners to your portfolio. Ultimately, the market will understand the progress made here.