A Lofty Enterprise

 | Aug 06, 2014 | 11:00 AM EDT  | Comments
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Stock quotes in this article:

epd

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kmp

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etp

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paa

If one wants a high-quality pipeline partnership, one should look no further than Enterprise Product Partners (EPD).

A few years ago, Enterprise decided to take the following route -- a simple ownership structure, with only one ticker symbol, and a less aggressive distribution approach that leaves a good bit of cushion. Typically, Enterprise now operates with a distributable cash flow coverage ratio of somewhere between 1.2x and 1.4x distributions, whereas most other pipeline master limited partnerships are somewhere between 1.0x and 1.1x. A few years ago, Enterprise's approach seemed old-fashioned and not aggressive enough, but it is clear now that the company set the standard for other midstream MLPs to follow.

Over the past few years, the market has rewarded Enterprise with a higher valuation than most other pipeline MLPs. For example, today Kinder Morgan Energy Partners (KMP) trades at 14.5x distributable cash flow, Energy Transfer Partners (ETP) trades at 14.8x DCF and Plains All American Pipeline (PAA) trades at 22x DCF. Enterprise, however, trades at 26x DCF. In the midstream MLP industry, valuation is important because these partnerships often issue equity to acquire and build pipeline systems. This year, with pipeline investment on course to be higher than ever, keeping a low cost of capital is essential.

Enterprise has taken advantage of its premium by building out multiple new systems, and as a result, the partnership has achieved consistent and impressive growth. For example, while Enterprise does not give yearly DCF guidance, this quarter the partnership was able to grow DCF by 9%. This growth, of course, makes Enterprise even more attractive to investors, which, in turn, keeps it at a premium to peers. One might call this a virtuous cycle.

Don't Be Hasty

This recent pullback in stocks has put forth some good deals, but most pipeline MLPs are not yet attractively valued. Remember, pipeline MLPs have enjoyed a long, sustained run-up in value, and this latest correction has only brought Enterprise back down to the level it was on back in June.

Enterprise is certainly more attractively valued than it was last month, at some 26x trailing-12-month DCF. A much better entry point would be at 22x DCF or lower. As you can see in the chart below, Enterprise has bounced off of 22x DCF a couple of times over the past 12 months. In addition, 22x DCF is also the lowest valuation year-to-date.

At that valuation, Enterprise would sit at $62.50 per share. The distribution yield would be a generous 4.6%, significantly better than where it sits today at 3.96%. Buying at this level would mean at least some kind of margin of safety and a higher distribution yield that will protect from additional downside.

Conclusion

Enterprise is definitely a best-of-breed pipeline MLP, and valuations couldn't reflect that more clearly. While I believe the partnership does deserve to trade at some premium to its peers, 26x DCF, in general, is a high valuation. The best thing for an investor to do here is continue to hold off and wait for a better time to buy. With the looks of how things are going right now, that time just might come.

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