Let the Profits Stream In From These 3 Companies

By Chad Henage - October 1, 2012 | Tickers: ENB, EPD, OKE | 0 Comments

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I'm always on the lookout for new investing opportunities, and a recent article by Aimee Duffy entitled “This Week in Midstream” caught my eye. The most interesting comment in her entire article was that the "energy industry will spend an estimated $130 billion-$210 billion expanding natural gas infrastructure over the next 20 years.” With this much money up for grabs, it should be a no-brainer that investors would want exposure to this portion of the energy industry. With this in mind, let's look at Enbridge (NYSE: ENB), Enterprise Products Partners (NYSE: EPD), and ONEOK (NYSE: OKE) as potential candidates for our investment dollars.

In her article, Aimee gave some insight into the strength of each of these companies. Her comment about Enbridge was that the company increased its cash flow and reaffirmed its year-long earnings forecast. Enterprise Products Partners increased profits and earnings on increased volumes. ONEOK reported a mixed bag of results, but operating income increased and the company also increased its full-year guidance. Clearly, it sounds like this sector is the place to be, with all three companies reporting positive developments. One challenge that faces investors when choosing any stock is making sure that they are not overpaying for the company's expected growth. Take a look at how these three companies compare on a valuation basis. 

While it's clear that investors are willing to pay for the expected earnings of each of these companies, ONEOK would seem to offer the best overall value. Though the company’s PEG ratio is slightly bigger than that of Enbridge, its growth rate is just over 2% higher as well. Over the long term, this higher growth rate should offset the slightly higher P/E ratio, and bring the shares down to a more reasonable valuation. On the other end of the spectrum, Enterprise Products seems far overvalued, selling at a much higher multiple than its two competitors. (Enbridge – 2, Enterprise – 1, ONEOK – 3)

One possible reason that Enterprise is selling for a higher multiple compared to its growth rate is that the company consistently beats earnings expectations. In the last four quarters, Enterprise has beaten earnings each time by an average of over 20%. By comparison, neither Enbridge nor ONEOK have been this consistent, with both companies missing estimates two times in the last four quarters. Though Enbridge missed estimates twice, for the full year it still averaged a 2% beat versus expectations. This was not the case at ONEOK, where its failure to meet earnings expectations caused an average miss of 6.6% per quarter. (Enbridge – 2, Enterprise – 3, ONEOK – 1)

In this industry, it's not unusual for companies to report negative free cash flow as they invest for future growth. However, what is fairly consistent is a decent dividend payout while investors wait for projects to be completed. Each of these companies offers an attractive yield, but Enterprise beats the other two with a yield of 4.78% over the last 12 months. Enbridge and ONEOK have fairly similar payouts at 2.89% and 2.76%, respectively. Since all three companies show significant capital expenditures that are using all or most of their operating cash flow, the company with the highest yield wins this contest. (Enbridge – 2, Enterprise – 3, ONEOK – 1)

It makes sense for companies in this industry to run up debt while they invest for future growth, but too much can be detrimental to the company's objectives. Comparing companies of different size and debt levels only makes sense if we use a ratio of long-term debt to their total assets. Using this measure, ONEOK has the lowest relative debt level, at 37.81%. Enterprise shows a level of 39.64%, and Enbridge carries the highest amount of debt at 43.04%. A lower level of debt can sometimes mean the difference between the company surviving to continue growing, or having to pull back capital spending to handle its loan payments. With this in mind, ONEOK on a relative basis is in a better position than its competitors. (Enbridge – 1, Enterprise – 2, ONEOK – 3)

In this battle for midstream supremacy, the total scores are Enbridge – 7, Enterprise – 9, ONEOK – 8. The final score is weighted towards Enterprise, primarily due to its higher yield and the consistency with which the company beats earnings expectations. However, if the company does not continue beating earnings estimates, its lower expected growth rate would change the scores completely.

While ONEOK would look like a reasonable second alternative, the company's streak of missing earnings estimates is troubling. As for Enbridge, Aimee mentioned that “the company recently had trouble with its Line 14 leaking in a Wisconsin field, and Canada's National Energy Board also announced a series of safety audits over the next few months.” This might be enough to keep cautious investors from considering this company altogether.

Using the measures that we did, Enterprise is our winner, but given the complicated nature of this business, I would suggest investors perform their own due diligence before choosing to invest. One way you can keep up with what's going on is to add one or all three of these companies to your own customized Motley Fool Watchlist. With as much money as the natural gas industry is expected to spend on midstream operations, one of these companies might be able to help stream profits into your portfolio.

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