Enterprise Products Partners: Top-Notch Energy Leader Remain Favorite Midstream Play (EPD)

I have been bullish on wide-moat midstream energy infrastructure leader Energy Products Partners (NYSE:EPD) units since May 2023, even as the underlying energy sector (XLE) tried to find its 2023 bottom. I followed up with another bullish call in August 2023 after its second-quarter or FQ2 earnings, urging investors to capitalize on its momentary weakness to add exposure.

As such, EPD unitholders have benefited from the dramatic recovery in the energy sector, defying the weakness in the S&P 500 (SPX) (SPY). The market has been struggling to come to terms with the surge in longer-term Treasury yields, as investors baked in higher hard landing risks, given the recent “bear steepening” phase.

Notwithstanding the broad market weakness, EPD has continued its upward recovery, outperforming the SPX since my August update. Supported by an attractive forward distribution yield of 7.5%, I expect EPD to maintain its resilience, notwithstanding the surge in longer-term yields.

Enterprise Products Partners is scheduled to report its third-quarter or FQ3 earnings scorecard on October 31. With EPD’s price action having recently re-tested its August 2022 highs, I believe market participants are expecting a solid performance and positive forward commentary by management.

Accordingly, Enterprise Products Partners is projected to post an adjusted EBITDA of $2.31B in Q3, up 2.1% YoY. I believe that makes sense, given the significant recovery in the underlying energy markets from its early summer lows. Even though EPD’s business model is highly robust and predicated on a long-term contractual basis, it isn’t immune to the cyclical price volatility of the energy market affecting its adjusted EBITDA, as seen in Q2, as it fell more than 10% YoY.

While Enterprise Products Partners has a well-diversified business model, its gross operating margin is mainly supported by the growth drivers in its natural gas liquids or NGL segment. As such, its high-quality and lucrative export asset base in NGL is assessed to be the key driver of its robust “A-” rated profitability grade. Therefore, the company remains well-positioned to capitalize on the demand drivers for its NGL and oil assets base, sustaining its profitability moat.

Given EPD’s efficient scale moat and diversified business model, I believe EPD would unlikely trade for a significant discount. Seeking Alpha Quant rated EPD with a “C-” valuation grade, suggesting it’s considered fairly valued.

However, its “D-” growth grade suggests investors might need to ask hard questions about the long-term viability of hydrocarbon transportation, processing, and storage as the world transitions toward renewable energy sources.

Despite that, given the solidly bullish undertones in the energy sector, I don’t see it as a red flag for now, suggesting it has reversed from a downtrend to an uptrend. As such, the fears of a disruptive renewable energy transition are likely overstated and damaged by the surge in long-term bond yields, which could “cripple” needed funding for these long-duration projects.

In contrast, EPD’s projects have shorter-cycle earnings accretion, allowing the company to continue generating robust distributable cash flow to sustain the payout to its unitholders.

EPD has proved its doubters wrong as its price action re-tested its August 2022 highs. While there’s selling pressure identified over the past week, I didn’t assess red flags suggesting significant caution must be heeded.

That said, I see the possibility of another welcomed pullback to help relieve some pressure over the recent upward surge. Accordingly, it should provide more opportunities for unitholders to accumulate at a more attractive level.

Rating: Maintain Buy.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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