Pay attention – EPD’s discount is no joke

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 and other energy commodities, like natural gas on the global market. Despite increasing attention on things like electric vehicles, “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. Oil and natural gas liquids (NGLs) are also used in a variety of other petrochemical applications and industries including plastics, home building, fertilizers, and pharmaceuticals to name just a few.

That broad, multisectoral reach is a big reason that the Energy sector continues to provide 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 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 still-anticipated “post-pandemic” phase should increase the flow of crude out of the Permian through the rest of this year.

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 it is well-established and recognized among its peers, with a very interesting fundamental profile that includes a large dividend and critical fundamental metrics like free cash flow and cash that have seen significant improvements over the past year. 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 and a built a useful backlog of pending orders into 2022. These look to provide a good tailwind into the new year year as previously suspended or deferred projects are carefully and deliberately brought back into production to keep pace with demand

EPD peaked in June of this year at around $26 per share, and has been following a downward trend from that point that appears to have found a bottom earlier this month at around $21. The stock has been picking up bullish momentum from that point, presumably on the back of recovering energy sector momentum that has felt the impact of omicron-driven uncertainty over the past month as that new variant has made its way across the globe. That variant has been the primary driver in large post-Thanksgiving spikes in infections, enough to put the airline industry through the wringer during Christmas as large numbers of flights were delayed or cancelled across the United States. As that momentum inevitably fades, however it is fair to expect that the market will turn its focus back to other economic questions. I think that includes an opportunity to turn attention back to whether stocks like EPD offer the kind of value that average investors like you and me should be paying attention to. My answer to that question right now is yes, but let’s run through the numbers so you can make up your own mind.

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 $47.5 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by about 8.33%, while revenues were almost 56.5% higher. In the last quarter, earnings improved by almost 2% while sales were about 14.6% higher. The company’s margin profile is healthy and stable; in the last quarter, Net Income as a percentage of Revenues in the last quarter was 10.82% versus 10.65% over the last twelve months.

Free Cash Flow: EPD’s free cash flow is healthy and growing, at a little more than $5.6 billion over the last twelve months. That marks an increase from about $4.1 billion in the quarter prior and $2.6 billion a year ago. The current number also translates to a Free Cash Flow Yield of 12.28%.

Debt to Equity: EPD’s debt to equity is 1.08, which is a little higher than I prefer to see, but also isn’t unusual for stock’s in this industry; however the company’s margin profile indicates operating profits should be adequate to service their debt. Their balance sheet has been a bit of a concern, as liquidity was limited, but it has also shown significant improvement as of the last earnings report; in the last quarter the company reported $2.35 billion in cash and liquid assets versus $28.1 billion in long-term debt, with no major near-term debt obligations. It is worth noting that cash increased from $611 million in the quarter prior and $334 two quarters before. Their operating margins are more than adequate to service their debt.

Dividend: EPD’s annual divided is $1.80 per share, which translates to a much larger-than-normal yield of about 8.29% 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 $28 per share. That means that the stock is nicely undervalued, with about 29% 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 January 2021 to its June peak peak at around $26. It also informs the Fibonacci retracement lines shown on the right side of the chart. From June to mid-August, the stock dropped back to find support around the 61.8% retracement line, bouncing off that line at around $21.75 to move higher into the beginning of September before dropping back below that level and finally bottoming at around $21 earlier this month. The stock has been picking up bullish momentum from that point, and is now touching immediate resistance at around $21.75, with current support back at around $21. A pivot high and drop below current support could see the stock test its 52-week low around $19, while a push above $21.75 should give the stock room to extend about $23, where the 38.2% retracement waits to offer next resistance.

Near-term Keys: EPD’s fundamental strength is improving, with a very useful value proposition. Its high dividend also offers an interesting argument for the stock as a useful long-term buy-and-hold position. If you prefer short-term trading strategies, a push above resistance at $21.75 could offer a signal to consider buying the stock or using call options, with a useful target price at around $23. A pivot high off of resistance at around $21.75 could be a useful signal to consider shorting the stock or buying put options, using current support at around $21 as a first profit target, and $19 providing a more attractive target if bearish momentum begins to accelerate.