Are midstream stocks like EPD still a good place to find value in the Energy sector?

Part of taking a smart, value-based approach to investing in the stock market involves keeping track of information on industry and economic trends that are likely to have broad residual impacts on market activity. One of the sectors that I think has a broad carryover effect on multiple other sectors in the economy is Energy, which is why I have learned that it’s useful to pay attention to the price of crude oil on the global market. Despite increasing attention on things like electric vehicles and “green” technologies and solutions aimed at reducing carbon footprints, the plain and simple fact of the matter is that oil continues to be a key driver of economic stability all over the world. That even applies to the production of the material assets used in “green” technologies like electrical car batteries and solar panels, to name just a couple of simple examples.

That reality is a big reason that the Energy sector provides important information about a number of different aspects of the global economy. One of the those elements that is very interesting is the difference between U.S. oil production versus the rest of the world. The financial markets use futures contracts on two primary types of crude oil to track oil prices. Contracts for Brent crude are the basic barometer for oil produced mostly in the Middle East by OPEC countries, while West Texas Intermediate (WTI) crude contracts act as the gauge for U.S. crude.

Over the last ten years, shale oil exploration and production have helped the U.S. narrow the gap between Brent and WTI crude production, with a major portion of shale oil coming from the Permian Basin, which is located primarily in Texas and parts of New Mexico and Oklahoma. The challenge associated with U.S. production – and one of the things that contributed to keep oil prices relatively low prior to this year’s pandemic, which cratered demand for oil and many petrochemical products – is that exploration and production of shale oil has exceeded the capacity of midstream companies to transport the oil to its primary distribution centers before it is sold throughout the world.

Midstream oil companies include those that have been involved in the ongoing construction and maintenance of pipelines and storage facilities out of the areas of the U.S. that drive shale production, like the Permian Basin; limitations of existing pipeline and storage capacity have been the primary reason that inventory out of that area in particular remained stuck in the Basin through 2019 and kept the entire industry waiting for new pipeline projects to be completed. Many of those projects were delayed in 2020 because of the pandemic, but were near enough to completion that a resumption of activity in the expected post-pandemic phase should increase the flow of crude out of the Permian through the rest of this year.

Adding to pressure on U.S. capacity this year is the reality that a new presidential administration often also means shifting priorities and attitudes about energy production. The Biden administration has taken an active role in curbing fossil fuel production, including a highly publicized shutdown of the Keystone XL pipeline project that was intended to provide a transportation system for Canadian oil into the Gulf of Mexico. A more bearish political environment acts as a headwind against U.S. oil production, which presumably will prop up prices; in fact, it has been one of the factors that has helped push both Brent and WTI crude prices above the $70 per barrel mark in the last few months.

Enterprise Products Partners (EPD) is one of the biggest midstream companies with operations in crude oil, natural gas and liquified natural gas (LNG) transport and storage among other things. EPD isn’t an easily recognizable company by name, but its fundamental profile is very interesting and includes a large dividend. EPD’s management has also noted that operating margins ticked higher over the past year, driven primarily by strong export demand for natural gas liquids logistics and consumer-led demand for petrochemicals such as cleaning products. These look to provide a good tailwind for 2021 as previously suspended or deferred projects are brought back into production.

EPD picked up quite a bit of bullish momentum from October to mid-March, rising from a low at around $15 to a peak at nearly $24 per share. From that point the stock settle into a range that didn’t push above $24 until late May. From that point, the stock has picked up bullish momentum again, peaking last week at around $26 per share. Does the stock still offer a useful value in spite of that increase, or has the stock’s rally pushed it beyond a useful value level? Let’s dive into the numbers.

Fundamental and Value Profile

Enterprise Products Partners L.P. (Enterprise) is a provider of midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, petrochemicals and refined products in North America. The Company’s segments include NGL Pipelines & Services; Crude Oil Pipelines & Services; Natural Gas Pipelines & Services, and Petrochemical & Refined Products Services. The Company’s midstream energy operations include natural gas gathering, treating, processing, transportation and storage; NGL transportation, fractionation, storage, and import and export terminals, including liquefied petroleum gas (LPG); crude oil gathering, transportation, storage and terminals; petrochemical and refined products transportation, storage, export and import terminals, and related services, and a marine transportation business that operates primarily on the United States inland and Intracoastal Waterway systems. EPD has a current market cap of about $55.2 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by about 5%, while revenues were a little more than 22% higher. In the last quarter, earnings improved by 25.5% while sales were almost 30% higher. The company’s margin profile is healthy and appears to be strengthening; in the last quarter, Net Income as a percentage of Revenues in the last quarter 14.65% versus 13.05% over the last twelve months.

Free Cash Flow: EPD’s free cash flow is healthy and growing, at a little more than $3 billion over the last twelve months. That marks a significant increase from about $2.6 billion in the quarter prior and $2 billion a year ago. The current number also translates to a Free Cash Flow Yield of 5.5%.

Debt to Equity: EPD’s debt to equity is 1.04, which is a little higher than I prefer to see; however the company’s balance sheet indicates operating profits should be adequate to service their debt. Their balance sheet is a bit of a concern, as liquidity is limited; in the last quarter the company reported $334.4 million in cash and liquid assets versus $27 billion in long-term debt, with no major near-term debt obligations. Their operating profile is more than adequate to service their debt, but considering that cash was more than $1.1 in the quarter prior, declining liquidity is something that should be watched in the quarters ahead.

Dividend: EPD’s annual divided is $1.80 per share, which translates to a much larger-than-normal yield of about 7.13% at the stock’s current price. A number of other companies in the Energy sector have been forced to reduce or even eliminate dividend payments, so EPD’s ability to maintain their attractive dividend and even increase it this year is a solid sign of strength.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at around $27.50 per share. That means that even with the stock’s increase over the last six months, the stock is moderately undervalued, with about 9% upside from its current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above covers the last year of price activity. The red diagonal line traces the stock’s increase from October 2020 to its recent peak peak at around $26. It also informs the Fibonacci retracement lines shown on the right side of the chart. The stock has dropped a little off of that high, marking immediate resistance at $26, with current support expected at around $24. A push above $26 should see room to move to about $28, based on the $2 difference between current support and immediate resistance. A drop below $24 should find next support at around $23 based on significant, consolidating pivot activity in late April and early May around that level.

Near-term Keys: EPD’s fundamental strength is solid, with a value proposition that is still pointing to a higher long-term target price; however the stock is starting to reach a level that making a compelling case for its value proposition doesn’t make much sense. Its high dividend also offers an interesting argument for the stock as a useful long-term hold. If you prefer short-term trading strategies, a push above resistance at $26 could be a good signal to consider buying the stock or using call options, with a useful target price at around $28. A push below $24 could be a signal to think about shorting the stock or buying put options, but keep in mind that downside is a bit limited, with next support at around $23.


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