Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Enterprise Products Partners L.P. – Fourth Quarter of 2020 IR Earnings Presentation

In Alphabetical Order by Ticker: EPD, MMP

By Callum Turcan

The energy market is recovering and that speaks favorably towards the midstream side of the oil & gas industry. Midstream companies operate pipelines, storage facilities, processing plants, marine terminals, gathering systems and other energy infrastructure assets. As global health authorities work to bring an end to the coronavirus (‘COVID-19’) pandemic, aided by ongoing vaccine distribution efforts, that should enable North American raw energy resources production to post a sustained recovery. Raw energy resources include crude oil, natural gas, and natural gas liquids (such as propane, butane, and ethane).

North American energy production took a big hit from the pandemic as global energy demand tanked. An eventual recovery in refined petroleum product demand, when the world can return to pre-pandemic activities, should help reverse that trend by providing a tailwind to raw energy resource pricing. Rising raw energy resources pricing, if sustained, would support greater investment towards the upstream side of the industry (operations involve extracting raw energy resources from the ground).

The precipitous decline in raw energy resources pricing seen during the first half of 2020 prompted private operators to reduce their capital expenditure expectations while the OPEC+ oil cartel last year agreed to hold a significant amount of supply off the market through 2022. Near-term crude futures have recently moved back towards the ~$60 per barrel range due to a combination of supply reductions and signs that demand is recovering.

Our two favorite companies in the midstream industry are Enterprise Products Partners L.P. (EPD) and Magellan Midstream Partners L.P. (MMP), two master limited partnerships (‘MLPs’) that we include as ideas in the High Yield Dividend Newsletter portfolio. Both companies recently reported fourth quarter earnings for 2020, and we will cover key highlights from those reports in this note.

Enterprise Products (EPD)

When Enterprise Products reported its fourth quarter earnings for 2020 on February 3, the firm noted it generated $2.7 billion in free cash flow (under Enterprise Products’ definition of free cash flow) last year, which was up 8% from 2019 levels. The company has not yet published its 10-K SEC filing covering 2020 as of this writing and did not include a cash flow statement in its latest earnings report, so we will have more to say on Enterprise Products’ financial performance in the future. Enterprise Products substantially reduced its capital expenditures last year and intends to continue scaling back its capital expenditures going forward, a strategy management reiterated during the firm’s latest earnings call.

During that earnings call, management noted the MLP currently has $3.6 billion in projects currently under construction that will come online over the next two years. The firm expects to spend $1.6 billion on growth-related capital expenditures this year, which is expected to fall down to $0.8 billion in 2022, according to recent management commentary. However, Enterprise Products may decide to sanction additional growth developments, though management stressed the MLP’s growth-related capital expenditures would not exceed $2.0 billion in 2021.

Please note the firm also intends to spend $440 million on its sustaining (or maintenance) capital expenditures this year according to recent management commentary, which includes $115 million on scheduled turnaround activities at some of its petrochemical (and other) facilities. As an aside, Enterprise Products has been steadily repurchasing a relatively modest amount of its units of late, including ~$200 million worth of unit buybacks in 2020.

Enterprise Products’ net operating cash flows and operating income were down by 10% and 17% year-over-year, respectively, last year as volumes across its operations plummeted. Even in the final quarter of 2020, most of Enterprise Products’ operations were seeing subdued utilization rates (compared to year-ago levels) though things are clearly improving. In the third quarter of 2020, Enterprise Products reported that its ‘NGL, crude oil, refined products & petrochemical pipeline volumes’ stood at 6.0 million barrels per day on average, which had recovered to an average of 6.5 million barrels per day by the fourth quarter of 2020.

Looking ahead, Enterprise Products is well-positioned to significantly grow its free cash flows, if the firm continues to keep a lid on its capital expenditures. At the start of 2021, Enterprise Products grew its annualized payout marginally, which represented its 22nd consecutive year of annual distribution increases according to recent management commentary. Units of EPD yield ~8.3% as of this writing, and we continue to like exposure to the midstream MLP in our High Yield Dividend Newsletter portfolio.

EPD's 16-page Stock Report (pdf) >>

     EPD's Dividend Report (pdf) >>

Magellan Midstream (MMP)

On February 2, Magellan Midstream reported fourth-quarter earnings for 2020. As with Enterprise Products, Magellan Midstream’s financial and operational performance faced significant headwinds last year due to the COVID-19 pandemic. Transportation volumes across Magellan Midstream’s crude oil and refined petroleum products pipelines plummeted in 2020 versus 2019 levels, which saw its GAAP revenues and GAAP operating income shift lower by 11% and 14% last year, respectively, on a year-over-year basis. Magellan Midstream divested some of its marine terminal operations in 2020, which weighed somewhat on its performance as well.

By the fourth quarter of 2020, things had started to rebound with Magellan Midstream’s distillate transportation volumes up year-over-year and its gasoline transportation volumes only down modestly year-over-year. The company’s crude oil transportation volumes were still down versus year-ago levels in the fourth quarter, though Magellan Midstream’s storage business was performing quite well with average storage volumes up meaningful year-over-year last quarter. Its aviation fuel transportation volumes were also significantly lower versus year-ago levels in the final quarter of 2020 as commercial air travel activity was and continues to be subdued, though ongoing COVID-19 vaccine efforts should eventually change that picture.

Magellan Midstream aims to continue pushing its capital expenditures lower going forward according to management commentary given during the MLP’s latest earnings call. Last year, Magellan Midstream spent $355 million on growth-related capital expenditures and that figure is expected to fall to $75 million this year, though management noted that the firm may increase its growth-related capital expenditures this year up to around $100 million if new growth projects are sanctioned. Additionally, Magellan Midstream expects its maintenance-related capital expenditures will decline from roughly $100 million in 2020 to around $85 million this year.

Capital expenditure reductions will go a long way in improving Magellan Midstream’s cash flow profile by better enabling the company to generate free cash flows. As an aside, the MLP has been steadily buying back its units of late (management noted the firm spent $277 million buying back its units last year in Magellan Midstream’s latest earnings call). The firm did not provide a cash flow statement in its latest earnings press release and had not yet published its 10-K SEC filing covering 2020 as of this writing. We will have more to say on Magellan Midstream’s financial performance in the future.

Looking ahead, management expects Magellan Midstream’s non-GAAP adjusted EBITDA and distributable cash flow performance will be broadly flat this year versus 2020 levels. The firm intends to keep its payout flat at current levels through 2021 according to recent management commentary. Magellan Midstream is actively seeking improvements in its cost structure, a strategy that included the company offering early-retirement packages last year. Units of MMP yield ~9.9% as of this writing and we continue to like exposure to Magellan Midstream in our High Yield Dividend Newsletter portfolio.

MMP's 16-page Stock Report (pdf) >>

     MMP's Dividend Report (pdf) >>

Concluding Thoughts

The distribution yields on the units of both Enterprise Products and Magellan Midstream are quite lofty, and while we caution that these midstream MLP’s have hefty net debt positions, they may be best-in-class. Still, both entities need to retain constant access to capital markets to refinance their debt burdens, ideally at attractive rates. Declining capital expenditures and rising utilization rates, if realized, should go a long way in improving both firm’s abilities to generate free cash flows this year and beyond. In our view, we see Enterprise Products and Magellan Midstream being able to maintain their hefty payout obligations going forward. We continue to like exposure to both Enterprise Products and Magellan Midstream in the High Yield Dividend Newsletter portfolio.

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Oil and Gas Complex Industry - BKR, HAL, SLB, BP, CVX, COP, XOM, RDS, TOT, COG, EOG, OXY, PXD, ENB, ET, EPD, MMP, KMI, PSX

Related: EPD, MMP, XLE, XOP, XES, CRAK, OIH, AMLP

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Callum Turcan does not own shares or units in any of the securities mentioned above. The Energy Select Sector SPDR Fund (XLE) is included in Valuentum’s simulated Best Ideas Newsletter portfolio. Enterprise Products Partners L.P. (EPD) and Magellan Midstream Partners L.P. (MMP) are both included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.