Institutional Products: The Market Will Regret the Ridiculous Valuation (NYSE: EPD)

thesis

I see a discrepancy between Enterprise Products Partners LP earnings forecasts (New York Stock Exchange:EPD) and its market assessments. On the other hand, I see an encouraging earnings growth curve in the immediate future as well as the near term long-term. In the near term, the volume of all products transported through the pipeline system set a record high in Third quarter of 2022. Margins in the main LNG pipeline segment were up significantly, resulting in gains of approximately 25% year-on-year as can be seen in the chart below (from approximately $223 in Q3 2021 to $278 in Q3 2021). in 2022).

In the long term, as one of the largest exporters of LPG (liquefied petroleum gas) in the world, I expect demand to remain strong. Demand from Europe should continue to rise as the EU intends to reduce its dependence on Russian gas to move on. And the demands in the United States must also remain strong, given the lack of investment in energy infrastructure over the past several years in the country, as I have repeatedly argued in my country. Other articles. Last but not least, EPD is involved in almost every major rock game in its sector. It is one of the most diverse members of the industry in terms of geographic diversity and product categories. Besides the natural gas and natural gas segment, it also transports a wide range of raw materials (ethane, propane, butane, etc.). Thus, risks to any one product line or geographical location are minimized.

However, his valuation is discounted significantly by the market – in the range of 20% to 35% I estimate to be detailed later. And in the remainder of this article, I’ll explain why this difference between its fundamentals and evaluation scales seems absurd.

A quick note before we move on, for MLPs, their “equities” should be called “Units” and then their EPS should be called Earnings Per Unit (“EPU”). But given that the article can be read by a group of readers, some of whom may not be particularly familiar with these terms, I will continue to mention stocks and EPS in the remainder of the article.

Big volume and strong margin

As mentioned above, Enterprise Products Partners LP has had record volumes moved through its pipelines, as evidenced by the asset turnover ratio (also known as asset utilization rate, AUR) shown in the top panel of the following chart. To wit, AUR was dialed in at 0.813x as of last quarter on a TTM basis. It nearly doubled from the low of 0.43x during the COVID outbreak and is also about 15% above its long-term average of 0.715x.

The combination of strong volume and favorable pricing environments resulted in healthy profits and margins. As mentioned earlier, margins in the main LNG pipeline segment were up approximately 25% year-over-year last quarter.

The margin from the LNG and natural gas segment was offset by a decrease in petrochemical and refined operations. But overall, their margins are at a healthy level by historical standards as measured by their EBITDA margin (shown in the bottom panel of the chart).

Looking ahead, as mentioned earlier, I anticipate demand from both Europe and the United States to remain strong given the geopolitical shift of energy landscapes caused by the Russia/Ukraine war. And then, I’ll explain why EPD is well positioned to take advantage of this shift.

growth potential

In the long run, the growth potential of a company is ultimately governed by two factors, namely return on invested capital (“ROIC”) and reinvestment rates (“RR”). And the EPD has healthy metrics in both areas. In terms of return on investment (ROIC), the chart below shows its current rate of return on investment (ROIC) hovering around 17%, well above its historical average of nearly 14%. In terms of reinvestment, the company has maintained a recovery ratio in the range of 20% to 25% in recent years.

A ROI of 17% and a RRA of 20% can lead to 3.4% ORG. And given the long-term pricing strength that EPD boasts, adding a sliding scale to inflation of 2.5% could push the growth rate to around 6%.

And then I’ll show that the 6% growth rate, when combined with the current valuation discount, really does present a very favorable yield profile in the years to come.

However, the evaluation is discounted

Enterprise Products Partners LP is currently priced at a discount based on the metrics you have checked. As a reliable dividend stock (dividend champ, in fact), the dividend yield has to be the most reliable valuation metric here. As can be seen in the chart below, its current yield of 7.36% is close to a decade high. It is 22% above its historical average of 6%, indicating a valuation discount of 22%.

The second chart below shows the price-to-earnings ratios, which indicates a larger discount. Its price-earnings ratio is about 11 times currently. Compared to its historical average of 17.68x, it’s discounted by about 35%.

The combination of a healthy growth curve and a large valuation discount provides an attractive return profile as summarized in the waterfall chart below. Specifically, I expect a total annual return of 9.2% in the next three to five years, consisting of:

1. 6% annual growth in its total profits as analyzed above.
2. Dilution of 2%, which is in line with its level in the last year. As a result, EPS (or earnings per unit) is expected to grow by 4%.
3. And finally, a valuation expansion of 5.2% annually (obtained by converting a valuation discount of 22% annually based on the dividend yield as analyzed above).

Risks and final thoughts

Enterprise Products Partners LP does face macroeconomic and specific risks though. In terms of macroeconomic risks, inflation is an ongoing concern. Or more precisely, increases in interest rates caused by inflation are a constant concern. As a typical player in the pipeline, EPD is highly leveraged and therefore sensitive to higher borrowing costs. In terms of its own specific risks, as mentioned above, it currently faces some headwinds in its petrochemical and refining operations. Also, the potential for it to grow in the US or abroad would also require building more terminals and thus significant capital expenditures.

Finally, the difference between Enterprise Products Partners LP fundamentals and valuation metrics seems silly to me. Absurdity in the stock market often indicates the potential for huge returns. And indeed, in this case, I see a potential annual return for Enterprise LP Products Partners close to double digits (9.2% based on my forecast). Finally, note that of the expected return of 9.2%, 7.3% will come from its dividend — which adds another layer of safety given its status as a top dividend payout.