Saturday, May 13, 2023

Enterprise Product Partners - Free Cash Flow Per Unit Since Q1 2019

We posted about first quarter earnings for Enterprise Product Partners, but it is worthwhile to go back and put them in historical perspective. Let's look at some income statement, balance sheet, and cash flow statement items for Q1 2023 compared with Q1 2020 and Q1 2019:

2023: $12.4B
2020: $7.5
2019: $8.5

Net income
2023: $1.39B
2020: $1.35
2019: $1.26

Unit count:
2023: 2,174,508,951
2020: 2,240,607,595
2019: 2,188,560,672

Net income / unit
2023: $0.63
2020: $0.61
2019: $0.57

Cash from operations
2023: $1.58B
2020: $2.01
2019: $1.16

2023: $0.73
2020: $0.90
2019: $0.53

NI+depreciation-Capex (FCF)
2023: $1.35
2020: $0.81
2019: $0.61

NI+depreciation-Capex (FCF) / unit
2023: $0.62
2020: $0.36
2019: $0.28

Total liabilities less current assets:
2023: $29.7B
2020: $28.4
2019: $28

It's nice to see the huge increase in "net income plus depreciation less capital expenditure per unit" over the four years from 2019 through 2023: from $0.28 in Q1 2019 to $0.62 in 2023. That measure should hopefully be a good proxy for the cash that the business will be able to use to distribute to unitholders and buy back units.

The current unit price is about $26, so in theory the 62 cents, on an annualized basis, could support a 9.5% unitholder return. Four years ago, the units were trading for more like $29. That was only a 3.9% implied return.

The reason we looked at "total liabilities less current assets" is to make sure that the company has not just been borrowing to pay the distribution.

Note that the First Trust MLP and Energy Income Fund (FEI) has EPD as its largest holding (10.9%) That closed end fund is trading for a 16.4% discount to NAV.

Midstream companies seem much more attractively priced than tobacco companies.


KJP said...

Regarding FEI, in addition to its management fee, note that it uses leverage and can have tax consequences that may be worse for certain investors than owning an MLP directly, e.g.: "Distributions of $27,137,342 paid during the fiscal year ended October 31, 2022 are anticipated to be characterized as taxable
dividends for federal income tax purposes." 2022 Annual Report at p. 22 (source: I believe forced selling by levered MLP funds was one of the causes of the extreme price movements in pipeline companies in March 2020.

As for EPD itself, over the least five years it has made a major transition in how it funds its growth. Years ago during the heyday of MLPs, it was funding new projects with debt and newly issued equity. It first transitioned to using FCF for the equity portion, and over the last few years has begun funding all growth with FCF. As a result, it has effectively been delevering. You can see the timeline on slide 93 here: (note the references to "self-fund equity" and "self-funded CapEx"). You can see an overview of the decline in leverage on slide 91.

Over the last few years they have slowly ratcheted down their disclosed target leverage ratios. So, it's unclear to me exactly what they intend to fund themselves going forward. If they continue not to use any leverage on new projects, their incremental ROEs ought to trend to companywide returns on capital. One attempt to calculate such returns is on slide 88 of the attached, though there are other ways to calculate it. If they began to use 2 - 2.5x leverage on new projects, they may be able to get high teens ROEs.

You also get the benefit of high insider ownership and aligned management alongside the tax benefits (to the holder and his/her heirs) of the MLP structure. Overall, if someone is inclined to consider buying an MLP to hold for many years, then I think EPD should be at the top of the list.

CP said...

Great comment, thank you.

What else do you like besides EPD?

KJP said...

EPD is my favorite of the pipeline companies and the only one I currently own. If there were big selloffs in the sector for some reason, Williams (in a non-taxable account) and Magellen would also interest me. Same goes for the mineral royalty companies, e.g., Black Stone and Dorchester. You've already written about the oil sands and met coal companies, and I think your reasoning on them is sound.

I also like Fairfax Financial, FRP Holdings, and IAC, but they are much different businesses than pipelines and don't all have high current cash flow. All three do give you high insider ownership, cheap valuations (at least on certain metrics), buybacks, a history of strong capital allocation (though a few missteps recently) and strong balance sheets.

To turn back to EPD briefly, it seems to have an insurmountable advantage in NGLs (who is going to overbuild them?). Many people may not realize just how important those are in developing countries. For example, the last Fairfax annual letter notes that a major achievement of the current Indian PM has been to "provide[] 100 million gas cylinders for women who used to cook with coal or wood." (pg. 15: EPD supplies alot of the fuel for those cylinders. (See slide 15 and 17: And there's more growth to come from people who would like to switch from burning wood or coal.

CP said...

I thought this was an interesting essay about Fairfax:

CP said...

Also liked the latest Sitio Royalties presentation

Slide 11 they talk about the market for private non-operating interests.

KJP said...

Yes, that is a good overview. Here's another:

Viking on CoBF also provides running commentary on Fairfax.

We'll see whether the combined ratio stays at 95%. I would prefer a longer track record of underwriting profit, but given the more recent underwriting history and the current state of the investment portfolio, it looks like it could be a fruitful 5-10 years (and hopefully longer).

KJP said...

To me, the way Sitio presents itself gives me pause. For example, in their presentation they repeatedly emphasize "Cash SG&A," but the proxy statement demonstrates that the executives are primarily compensated with non-cash RSUs and PSUs, and the performance vesting criteria for the PSUs isn't particularly demanding (50% vesting at 0% total shareholder return). So if they are primarily using non-cash comp, why are they highlighting cash SG&A?

They also highlight the amount of production they've recently added through acquisitions. But what is the decline rate on what they are buying? Anyone can show near-term production increases through acquisition, but that doesn't mean they are creating any value.

CP said...

Sitio was initially backed by a private equity fund called Kimmeridge. They are still the largest shareholder and one of their partners is the chairman of the board.

CP said...

I liked this discussion on the Q4 earnings call:

In 2023, we will also be acutely focused on gaining additional efficiencies and implementing new technologies to help us continue to scale and provide competitive advantages that will allow us to replace less effective third-party vendors. Professional management of oil and gas minerals is still a relatively new concept, and we believe there is a large opportunity to transform the industry, which currently uses many outdated methods and tools.

Technological advances geared specifically for the challenges of an independent mineral owner are in their very early stages of development, and we are piloting a number of new efficiency tools. We also see a large opportunity to fundamentally improve the relationship between operators and mineral owners while saving money and time on both sides and eliminating inefficiencies in the system from duplicative work done by hundreds of operators and tens of thousands of mineral owners.

So we're really excited about a couple of the initiatives we have starting this year. And we sit here in a pretty unique position where we view ourselves as the permanent owners of these assets. And we're buying assets and people who maybe aren't necessarily the permanent owners, and that's why they're selling them to us.

And as the permanent owners, we're going to manage them differently, meaning we're going to make sure we're getting paid timely on every well, every month. Making sure that the decimals on which we're paid matched the decimals on which we believe we own. And we track these things monthly. We prioritize the missing payments that we believe we're owed, and we pursue them with operators.

And to do that, a business of our scale with 5,000 leases, over 25,000 wells, it takes a lot of technology and data management to do it efficiently. And so we are developing tools on our own just because there are -- there's no suite of software that effectively manages a minerals business. So we've spent a lot of time in 2020 building out our data warehouse and data management system, and that has allowed us to scale up the way that we have.

And now we're working on ways to make our team more efficient by having them touch fewer of the data points and just automatically process some of the data points. So things like revenue or division orders are just begging for efficiency measures. So we're working on those things this year.

CP said...

Also on the Q4 call:

At the end of December, we made our first quarterly amortization payment at par of $11.25 million on our senior unsecured notes, reducing the outstanding principal from $450 million to $438.75 million. The senior unsecured notes prohibit us from making stock repurchases, which we would like to be able to opportunistically do with the 35% of our discretionary cash flow that we don't distribute as a quarterly dividend.

We are monitoring market conditions for an opportunity to refinance these notes either after the first call date on September 21 of this year, or sooner, if warranted, to provide our company the appropriate amount of capital allocation flexibility. Regarding our outlook for additional large-scale acquisitions, we remain focused on our underwriting discipline and believe that there will be fewer opportunities that meet our returns criteria in 2023 compared to 2022.

There is still a large opportunity set of high quality and sizable minerals positions to consolidate, and we have made several offers to acquire additional mineral assets this year, but the bid-ask spread has been too wide. If attractive consolidation opportunities do not materialize, we will continue to focus on strengthening the balance sheet by paying down our prepayable debt and building liquidity for when market conditions normalize.

CP said...

CoBF "Viking" link:

CP said...

November 2021:
Even without growing earnings, if Magellan traded to a 5% dividend yield (where it was in 2017-2018), that would be 60% upside to the current share price, or $80. A $60 call for Jan 2024 last traded for $1.30. If the stock revalues between now and then, that's 15x upside. [An ATM $50 call has IV of only 13% and trades for $4. That would be 7.5x upside with breakeven at $54 - MMP traded at $53.5 in June.]

That Jan 2024 $50 call is trading for $14.20 today, a 3.55x bagger. Can't believe the IV on an inflation-protected real asset was only 13%...

The January 2025 EPD calls are $2.55 for an ATM ($25 strike with $26 share price), $1.67 for $27 strike, and $0.75 for a $30 strike.