Energy master limited partnerships have quietly carved out a role as the leading industry in the market over the past year, rising 45% at a time when the broad U.S. market is up 16% and the energy sector is up 12.5%. Add the 5% in annual dividend income that MLPs provide on average, and the differential is even more dramatic.
Naturally there are better and worse MLPs, so let’s look at one that has performed best and has been one of my top picks in the past quarter: Enterprise GP Holdings (EPE). It’s the largest pipeline operator in the world by revenue, and its shares were up 7% in June — a time when the broad market fell 3.8%.
Despite all the advances in renewable energy, the modern world runs on petroleum, natural gas, and other non-renewable carbon-based resources. Trucks and airplanes continue to gulp down millions of barrels of oil each day, of course. Every winter, people need gas to heat their homes and in the summer it furnishes the power for air conditioning.
Behind the scenes, Enterprise Holdings operates an expansive 49,000-mile network of pipelines that delivers these resources from wells to centralized storage facilities throughout North America.
Based in Houston, the company mainly operates in the central United States with 25 processing plants in Colorado, Louisiana, Mississippi, New Mexico, Texas, and Wyoming. Most plants focus on purifying natural gas from its raw form into a commercial fuel.
EPE is classified as a master limited partnership, or MLP, a corporate structure that combines the tax benefits of a limited partnership with the liquidity of a publicly traded security. This entity nearly eliminates federal and state taxes, allowing the company to pass a majority of its cash flow directly to investors in the form of dividends. Think of them as REITs that own pipelines instead of buildings.
Unlike large oil and gas exploration companies that are dependent on the price of oil, EPE’s structure allows it to hedge against commodity price fluctuations. Its refining and distribution businesses boom when demand and prices increase. But when supply outstrips demand, EPE earns a lot on storage fees. Example: Even as the price of natural gas fell dramatically from $11.32 in July 2008 to in $3.43 a year later, EPE logged positive cash flow and paid its 5.3% annual dividend.
EPE provides independent oil owners, such as hedge funds, title transfer services for crude and gas held at America’s largest energy products depot in Cushing, Oklahoma. EPE also charges for storing and withdrawing oil reserves from the facility. So basically it nicks customers for fees coming, staying and going. It’s like an integrated airline/hotel operator that charges customers for travel to a resort, the time spent at the resort, and travel away from the resort. Not a bad business model.
EPE has acquired three smaller pipeline partnerships since 2007 that have diversified its portfolio so that it is less susceptible to geographic disruptions. Morningstar analysts are particularly optimistic about its recent acquisition of Energy Transfer Partners, calling it one of the best and fastest-growing natural gas transportation networks in the industry.
Shares have risen more briskly in the past year than other MLPs, and certainly much more than the broad market. Since July 1, 2009, shares are up 98%, vs. +48% for Alerian MLP fund (AMJ) and 20% for the S&P 500. Dips to the 30-week average have been the best buying opportunities, and that’s where my subscribers picked it up on the last day of May.
Going forward, EPE has strong growth opportunities, stable cash flow, and a healthy dividend that have together earned the stock a 23 P/E multiple. My earnings estimate for 2011 is $2.71 per share, which gives us a $62 price target — 32% higher than the current quote. EPE is a buy on dips.
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