The One Energy Infrastructure Company I’m Buying Today
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As I continue to build up the “No Drip, No Mess” Portfolio, I’m again going back to the well, so to speak, this time with a company that takes what’s produced at the well and transports it to market centers. As one of the leading North American midstream companies, Enterprise Products Partners (NYSE: EPD) provides a range of services to producers and consumers of natural gas, NGLs, crude oil and refined products. The addition of Enterprise to the portfolio brings our energy allocation up to my target of 10% of the portfolio, roughly in-line with the S&P. Over time I might bump up the allocation to between 12% and 15% of the portfolio because I like the long-term fundamentals of North American energy.
The large distributions produced by the MLP structure will continue to grow as the company works through the $8 billion worth of projects currently under development. As these products come on line they’ll supply us with a continual flow of cash to reinvest in exciting growth stocks that are beginning to show up on our watch list. Enterprise is a company I know well and instead of just buying units outright, I want to write puts. The units have been on a tear the past month so I’d like to earn some income while enabling us to potentially pick up units a bit cheaper before the year is out.
Other than their tightly integrated system of assets, I like the simplicity of the ownership structure at Enterprise the best because you know exactly what assets you are investing in. There is no General Partner with incentive distribution rights to deal with, nor is there a drop down MLP that’s also publicly traded that owns part of an asset. You get the idea. Take Kinder Morgan, Inc. (NYSE: KMI) for example where the company boasts that with them you have four ways to invest: Kinder Morgan, Kinder Morgan Energy Partners, Kinder Morgan Management and El Paso Pipeline Partners. Investors need to do an incredible amount of due diligence just to determine which publicly traded vehicle owns the assets they want to be invested in. Or take DCP Midstream Partners (NYSE: DPM), which is the master limited partnership formed by DCP Midstream LLC, which itself is a Joint Venture between Spectra Energy and Phillips 66, which were previous spin-outs of Duke Energy and ConocoPhillips, respectively.
It wasn’t always simple at Enterprise. They used to have a publicly traded GP and a drop down vehicle called Duncan Energy, both of which they subsequently reacquired. Also, until just recently they’d owned units of Energy Transfer Equity (NYSE: ETE) as they at one time were part of the empire-building club that was earning a lot of fees for Wall Street investment bankers. Now the fees are the ones they are earning on the behalf of shareholders as they’ve simplified the ownership structure and are concentrating on organic growth projects.
The second -- and for our purposes most important -- reason to invest in Enterprise is to capture their large distributions that will only get larger over time. Distributable cash flow has grown from a billion dollars in 2007 to nearly $2 billion in 2011. They’ve only been distributing about 70% this cash to shareholders, retaining the rest (along with any gains from assets sales such as their units of ETE) to fuel their growth projects. This reduces their reliance on capital markets and gives room for future distribution increases.
Why Write Puts?
The current price for Enterprise’s units of just over $51 is a fair price to pay for the company especially given their current yield at just under 5%. I just personally favor writing puts to seed a portfolio as you get some cash now and a better start price later. The biggest risk is in missing the upside if shares soar, but given that this is a slower growing MLP I don’t see a huge upside in the short term. In an effort to maximize the initial cash flow I’m going to write December $50 puts for about $250. This gives us a 5% yield on the cash required to hold the trade open and is equivalent to banking a year’s worth of dividends today. We’ll take that cash and earmark it for a tastier growth company in the very near future. If we’re unable to pick up the units come December, plan on more of the same unless the units do spike. If that’s the case, there are plenty of midstream companies we can invest in with similar prospects.
Risks and why sell?
My biggest concern at Enterprise is that they lever up to make a massive acquisition and end up overpaying. The company currently has $14.6 billion of debt outstanding with a weighted average maturity of 12.2 years and a weighted average interest rate of 5.9%, giving the company a fairly conservative debt profile. With excess liquidity of $3.6 billion and investment grade credit they certainly have the capacity for something big. As long as the company continues to build new pipelines and facilities organically they shouldn’t need to resort to buying someone and with an $8 billion cap ex pipeline. They’ve got a long way to go before they run out of projects.
For the “No Drip, No Mess” Portfolio I like how we are approaching our energy allocation. We’re using puts to buy these companies cheaper and we’re buying companies less tied to the volatility inherent in the commodities thanks to their smart hedging or fee-based businesses. I’d like to eventually add an energy service company to the mix when we top out the allocation. For now though I’m content to wait until our puts are assigned, continually going back to the well with another round of put writes at expiration if we’re not assigned. I think you’ll find us to be served well with this strategy as we’ll reduce both risk and volatility within the portfolio while generating positive returns along the way.
latimerburned owns shares of Phillips 66, ConocoPhillips, and Enterprise Products Partners L.P. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend El Paso Pipeline Partners LP, Enterprise Products Partners L.P., and Spectra Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.