2 Exorbitant Safe Returns: Western Midstream And Enterprise Products Partners (EPD)
High return and low risk are two adjectives that many investors believe do not belong in the same phrase. However, thanks to a unique combination of macroeconomic events and strong political views impacting Wall Street investment trends, we today are looking at a fairly long list of common stocks that offer very high returns without too much risk.
Today we’re going to look at two such stocks – Enterprise Products Partners (NYSE:EPD) and Western Midstream Partners (NYSE: WES) – both of which have strong investment-grade balance sheets, stable cash flow business models, and extremely high and very secure payout yields.
Note: Both EPD and WES issue a K-1 tax form, so keep that in mind before adding them to your portfolio.
#1. EPD: The Ultimate Retiree SWAN Investment
EPD has arguably the best combination of midstream infrastructure assets, management and balance sheet strength in the industry today. Its portfolio of assets is well-diversified, high-quality and battle-tested, earning it a Wide Moat rating from Morningstar. Meanwhile, insiders own about one-third of the company’s common stock, and returns on invested capital have consistently been in the double digits, regardless of the macro environment. Last but not least, its BBB+ credit rating is on par with the best in the industry and has enabled management to consistently increase distribution during industry booms and busts.
After releasing first quarter results, EPD’s asset, management and balance sheet ratings remain excellent in our view. Pipeline transportation volumes were up 16% year-over-year, crude volumes at its marine terminals soared 39%, and gas pipeline volumes jumped 20%. Meanwhile, its $4.6 billion in capital projects underway, combined with the synergies and growth opportunities offered by Navitas Midstream, indicate that EPD should have a long growth streak ahead of it. In fact, management doubled down on that on the earnings call when asked by analysts whether growth investments remain the top priority for excess cash flow going forward as opposed to unit buybacks.
That said, management also remains focused on returning capital to unitholders through distribution. Distribution coverage was a whopping 1.8x in the first quarter, making it safer than ever and giving them plenty of avenue to continue to grow it in the quarters and years to come.
Last but not least, the balance sheet remained in excellent shape with leverage at 3.4x and trending lower as EBITDA is expected to continue to grow. Liquidity was also impressive at $3.9 billion in combined available credit capacity and unrestricted cash.
#2. WES: ultimate combination of yield, redemptions and growth
WES is an oil midstream company that collects, processes and transports natural gas and natural gas liquids (ie, NGLs). The Company operates assets located in Texas, New Mexico, the Rocky Mountains and north-central Pennsylvania. As a midstream company, WES stands between the production of natural gas (upstream) and the delivery of natural gas to end users (downstream).
As a midstream company, the company generates substantial free cash flow from established assets that have required years of capital investment. The company has barriers to entry due to the high level of capital investments and regulatory approvals needed to grow the business.
At the beginning of January 2020, Occidental Petroleum (OXY) created WES in its own company. This decision was made so that Oxy Petroleum could deleverage the newly created WES business and Western Midstream could focus on pursuing opportunities unique to its midstream assets.
In fiscal 2021, the company generated $1.45 billion in FCF after approximately $315 million in capital expenditures. It should be noted that much of the money invested in capital expenditures is in growth investments, which gives management the opportunity to invest in areas that will grow the business instead of shrinking. just keep the assets.
Additionally, the company escalated its payout policy, pledging to pay a payout of $2/unit for the year, offering investors an 8% payout at $25/unit. When you count all the cash flow generated by the business, the business can generate a double-digit return for unitholders. We believe this business will continue to create strong free cash flow for unitholders, supporting strong performance for years to come.
WES management has proven to be efficient in allocating capital, and its plans for the future appear to reflect the same management of capital.
In the most recent quarterly report, the company explained how it had returned approximately 18% of the enterprise value of the business to unitholders since January 2020, when the company was spun off from Oxy Petroleum. This is important because the company has essentially created ~$2.8 billion in free cash flow since the spin-off, and we can see the money has been put to good use.
For 2022, management expects approximately $1.25 billion in FCF for 2022. With approximately 400 million units in circulation, this means the company will pay out $800 million in distributions. This distribution is an increase from last year, and you can see that it is well covered by cash flow:
Based on current market conditions and estimates, we expect to declare a quarterly base distribution of $0.50 per unit, beginning with our first quarter 2022 distribution, representing an increase of approximately 53% over compared to the distribution declared in the fourth quarter of 2021. the new base distribution will result in an annualized cash distribution of $2 per unit.
– Transcription of Q4’21 results
After paying the distribution, the company will have approximately $425 million of FCF to use for debt repayment or opportunistic unit buybacks.
Another quality we like about WES is that the majority of the company’s cash flow comes from fee-based contracts. Because the contracts are paid, the company still makes money even if lower volumes are executed, and it has minimum volume commitments in place to ensure that even if commodity prices fall, it there will always be some level of throughput. (volume) on which WES will earn money:
We believe that a large majority of our cash flows are shielded from direct exposure to commodity price volatility, as 93% of our natural gas volume at the wellhead (excluding interests) and 100% of our crude oil and produced water throughput (excluding equity investments) were managed under fee-based contracts for the year ended December 31, 2021. Additionally, we mitigate volumetric risk through volume commitments minimum and cost-of-service contract structures. For the year ended December 31, 2021, 81% of our natural gas throughput, 96% of our crude oil and NGL throughput, and 100% of our produced water throughput was supported by either minimum volume commitments with associated compensation payments or cost of service commitments.
– WES 2021 10-K
At current prices, WES offers investors double-digit free cash flow for unitholders. Investors would see the returns from the distribution, unit redemptions, capital investments and debt repayment that the massive cash flow would go towards.
It is estimated that WES will generate $3.75/unit of distributable cash flow in 2022, meaning the business offers a DCF yield of 15% at a unit price of $25. From 2022 to 2026, cash flow per unit is expected to grow at a strong CAGR of 13%, which means that each year you will earn a higher return on your initial investment:
We believe this attractive valuation gives us the opportunity to buy a cash flow generating business with a double digit return for unitholders.
Key takeaway for investors
Both EPD and WES have strong cash flow business models and attractive yields. While EPD is unrivaled in terms of balance sheet strength and quality of management and its asset portfolio is considerably stronger than that of WES, WES also has very good ratings in each of these areas.
Meanwhile, its valuation looks very attractive, while EPD’s looks attractive, but not as lucrative as WES’s.
WES’ EV/EBITDA ratio is 8.25x compared to its 5-year average of 10.15x, implying significant upside potential through multiple expansion. Meanwhile, its forward distribution yield is 8.27%. In contrast, EPD’s EV/EBITDA is a full turn higher at 9.30x (although it warrants a higher multiple and has similar upside potential from its 5-year average of 11.11x ) while its forward payout yield is 7.18%, 109 basis points lower than WES.
However, where WES really stands out in the valuation department is its price below the DCF multiple and its potential for stronger DCF growth per unit in the foreseeable future. EPD has a P/DCF ratio of 8.2x while WES has a P/DCF ratio of only 6.25x. On top of that, EPD is expected to grow its DCF per unit at a CAGR of 4.9% over the next five years, while WES is expected to grow its DCF per unit at a CAGR of 7.6% over the same period. . This higher growth rate is largely due to the fact that WES retains a significantly larger share of its DCF than EPD and is able to buy back shares at very low multiples.
While we think both MLPs deserve a place in an income investor’s portfolio, WES is a more solid buy at the moment, in our opinion, given its significantly cheaper valuation and commitment to returning plenty. cash flow to investors through distributions and redemptions.