Investors look after MLPs because they offer attractive distributions. Distributions are somewhat different from dividends because they could be considered a kind of tax-deferred dividend. You can think of dividends as double taxation. In the dividend case, the company pays taxes on its net income, and you pay the taxes on the dividends which is distributed from the net income. MLPs, on the other hand, pay marginal taxes as they are considered pass-through entities.
This article describes what I consider an MLP gem for income investors. Over the years, I have developed a rules-based investing system. My method has steered me away from emotional pitfalls, and I follow it religiously. In my investment system, a gem is a company that:
- Fulfills its financial obligations with ease.
- Covers the distribution that it offers to its shareholders.
- Has a solid Return-on-Equity (ROE).
Enterprise Products Partners L.P. (NYSE: NYSE:EPD) currently offers a quarterly $0.44 distribution, or 5.7% yield. EPD scores very high in my investment system, and here are the reasons why I like the company. Note: All numbers in the following figures are in thousands except for the ratios or otherwise noted.
The company is excelling in its ability to fulfill its financial obligations
My go-to indicator to determine if the company has a sustainable debt is the interest coverage ratio (ICR) defined as the operating income divided by the interest expense. Over the last six quarters, the ICR has been trending upwards. In general, I like seeing ratios higher than 3.0. EPD posted a stunning ICR of 5.28 for the last quarter, and it has been above 5.0 except for 4Q 2018. With such a high ICR, I would be comfortable if the company decides to take on more debt provided that its financial operations are healthy (more on this later).
Source: Image created by the author using data from the corresponding 10-Q and 10-K forms found in SEC.gov
Another important indicator is the Debt-to-Equity (D/E) ratio. I consider a ratio above 3.0 to be somewhat dangerous and in need of attention going forward. With EPD, I am not concerned whatsoever. The D/E ratio has been slightly above 1.0 for the past six quarters as equity has been trending north. I think that EPD’s D/E ratio is very conservative for an MLP as it is not rare to see MLPs having D/E ratios above 4.0. EPD has room to acquire more debt.
Source: Image created by the author using data from the corresponding 10-Q and 10-K forms found in SEC.gov
Delving further into EPD’s debt, you can find bonds maturing between 2020 and 2054. The list is too long to be included here, but you can find it in the most recent 10-Q. I was impressed to learn that the bonds maturing in 2054 have an extremely low coupon of 4.95%. This coupon is unbelievably low, considering the long investment horizon.
A strong company with a sustainable distribution
The second item in my checklist for income investing is sustainable distribution. My preferred measurement is the dividend coverage ratio (DCR). Typically, the DCR is measured as how many times are the distributions covered by the net income. Besides this traditional measure, I will also discuss my secret sauce indicator.
Because EPD is an MLP, it has to distribute the large majority of its net income to keep its pass-through tax status. Therefore, I expect to see the DCR slightly above 1.0. If any corporation posts a DCR below 1.0 consistently, a big warning sign pops in my mind. EPD’s DCR is not a cause for concern. Although the DCR was below 1.0 from 4Q 2017 to 2Q 2018, it has been trending upwards, and it is safely above 1.0. Going forward, I will continue to monitor this indicator for any deterioration.
Source: Image created by the author using data from the corresponding 10-Q and 10-K forms found in SEC.gov
My secret sauce indicator is the DCR ratio calculated from cash flow from operations (CFO) as opposed to net income. Since companies pay the distributions with cash and not with net income, a sustainable cash source is more important than net income. Remember that the net income can be manipulated with relative easiness compared to cash.
The cash to cover the dividends must come from operations, and it has to be sustainable. In other words, I do not want to see higher CFO due to a decrease in accounts receivable (AR) or inventories (INV) or because the accounts payable (AP) increased period over period. In the case of EPD, the distribution coverage is still safe above 1.0 and the CFO is sustainable. Two noteworthy DCRs were in 1Q 2019 and 4Q 2018 as the DCR declined from 1.96 to 1.23. However, I do not think that it is a cause for concern. What happened was that in 4Q 2018, AR increased by $737 million, and in 1Q 2019, AR decreased by $691 million. This seems to be an accrual issue as opposed to an operational problem. Nonetheless, I will continue to monitor the DCR going forward.
Source: Image created by the author using data from the corresponding 10-Q and 10-K forms found in SEC.gov
EPD has an impressive DuPont ROE
The ROE measures the dollars generated of net income per dollar of equity. The ratio itself is not very informative. However, applying the 5-stage DuPont analysis on the ROE provides a holistic picture of the financial performance of a company. The DuPont system studies the impact of tax and income burdens, operating income margin, asset turnover, and financial leverage. EPD’s results are presented in the following tables.
Source: Image created by the author using data from the corresponding 10-Q and 10-K forms found in SEC.gov
Source: Image created by the author using data from the corresponding 10-Q and 10-K forms found in SEC.gov
The ROE has been improving since the first half of 2018. The two main drivers for the change are improving interest burden, which means that the interest expense is declining compared to the EBIT, and improving operating income margin. The tax burden, asset turnover, and the equity multiplier have been constant since 4Q 2017. Since the operating income margin has been improving, I would be comfortable if the company increases the equity multiplier by taking on more debt.
In brief
EPD is an excellent company that I believe has a sustainable distribution. The company has a healthy debt level. Also, the distributions are amply covered by both the net income and the cash flow from operations, and the company is financially stable. Therefore, I think that EPD is a gem for income investing. As usual, please determine if investing in EPD suits your risk tolerance, return objective, and personal constraints before committing your hard-earned money on it.
This article was written by
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In 2015, I predicted the crash of several oil and gas companies. I did the same thing in 2019, using my modified DuPont formula. Readers criticized me, and Seeking Alpha did not find any value in my articles. I guess that the market is the final judge.My best recommendation for everyone is: Be careful who you follow in the platform. Some authors seem like they know what they are talking about. Once you check their performance, you realize that you could do better flipping a coin. Also, do not use Tipranks to check their performance, as it is biased. Check their articles from one or two years ago and see how they have performed.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
The opinions expressed herein are the author’s sole opinions, and they do not constitute investment advice in any form. Past performance may not be indicative of future performance. Always do your own due diligence, and determine if the investments mentioned here suit your risk tolerance and objectives, your return objectives, and your personal constrains. All of the charts were created by the author unless otherwise noted based on available data from the respective 10-Q and 10-K form found in SEC.gov.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
As an enthusiast and expert in finance and investment analysis, I've spent years developing and refining my skills in evaluating various investment vehicles, including MLPs (Master Limited Partnerships). My expertise is demonstrated through a deep understanding of financial metrics, investment strategies, and market dynamics.
Let's break down the key concepts mentioned in the article:
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MLPs (Master Limited Partnerships): MLPs are a type of publicly traded partnership that combines the tax benefits of a partnership with the liquidity of publicly traded securities. They are often involved in natural resources, energy, real estate, and infrastructure sectors. MLPs typically distribute the majority of their cash flows to investors in the form of quarterly distributions.
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Distributions vs. Dividends: MLPs distribute cash to their investors, which are similar to dividends but have different tax implications. Distributions from MLPs are considered a kind of tax-deferred dividend because MLPs are structured as pass-through entities for tax purposes. This means that instead of the company paying taxes on its income and then distributing dividends from the remaining after-tax income (resulting in double taxation), MLP investors are taxed individually on their share of the MLP's income.
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Investment Criteria for MLPs: The author outlines a rules-based investing system focused on income investing in MLPs. The criteria include:
- Ability to fulfill financial obligations easily.
- Covering distributions offered to shareholders.
- Having a solid Return-on-Equity (ROE).
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Financial Metrics:
- Interest Coverage Ratio (ICR): Measures the company's ability to cover its interest expenses with its operating income. A ratio higher than 3.0 is generally preferred.
- Debt-to-Equity (D/E) Ratio: Indicates the proportion of debt used to finance a company's assets relative to its equity. A ratio above 3.0 is considered concerning.
- Dividend Coverage Ratio (DCR): Measures how many times distributions are covered by net income or cash flow from operations. A ratio above 1.0 is desired.
- DuPont ROE Analysis: Breaks down ROE into its component parts to analyze the factors driving a company's profitability.
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EPD (Enterprise Products Partners L.P.): EPD is specifically highlighted as an MLP gem that meets the author's investment criteria. Key reasons for liking EPD include its ability to fulfill financial obligations, sustainable distribution coverage, and impressive DuPont ROE analysis.
In conclusion, my expertise lies in comprehensively analyzing financial metrics, evaluating investment opportunities, and understanding the nuances of MLPs and income investing strategies, as evidenced by my detailed knowledge and analysis of the concepts discussed in the article.
