Editor’s note: This column is part of our Best Stocks for 2018 contest. Charles Sizemore’s pick for the contest is Enterprise Products Partners (NYSE:EPD).
As we approach the end of June, my pick in InvestorPlace’s Best Stocks for 2018 contest — blue-chip natural gas pipeline operator Enterprise Products Partners (NYSE:EPD) — is up a modest 6%, putting me in eighth place.
A 6% total return isn’t a disaster in a year in which the S&P 500 is up less than 2%, as it is at the time of this writing. But it’s a far cry from the 106%, 85% and 59% year-to-date returns currently enjoyed by Etsy (NASDAQ:ETSY), Twitter (NASDAQ:TWTR) and Chipotle Mexican Grill (NYSE:CMG).
Looking Forward in EPD Stock
I never like conceding defeat, and there is still a lot of time left in 2018. But barring a total collapse in tech (and burrito) stocks — and a major rally in conservative dividend players like EPD — it’s going to be no easy feat.
That’s OK. You can’t win ‘em all. But if I can get my readers a respectable return without taking excessive risk, then I’ve done my job. And regardless of what happens with the rest of the contestants for the remainder of 2018, I expect Enterprise Products to be one of the best performers in the second half. Total returns of well over 20% this year should be achievable.
As a quick review, Enterprise Products is one of the largest pipeline companies in the world with approximately 50,000 miles of pipelines carrying primarily natural gas liquids. It also owns a veritable empire of storage facilities, processing plants and export facilities.
Enterprise Products’ mediocre returns this year have very little to do with company performance. Enterprise has continued to plug along as always, and first-quarter operating results were excellent. Enterprise boosted distributable cash flow to a record $1.4 billion, easily covering its distribution by 1.5 times. This MLP has one of the safest cash distributions in the sector, and it’s not at all shy about raising it. Last quarter, Enterprise marked its 55th consecutive quarter of distribution hikes, raising the payout by about 3%.
The lack of investor enthusiasm has far more to do with interest rates fears and, to a lesser extent, energy prices.
Rising bond yields hit MLPs particularly hard and from two distinct fronts. The first is operational. MLPs tend borrow heavily to finance their growth projects, and every dollar paid in interest is a dollar no longer available to finance new growth or to distribute to unitholders.
MLPs also compete with bonds as income investments. Rising bond yields mean falling bond prices … along with falling prices for competing assets like MLPs.
I’m not particularly concerned on either front. Enterprise Products carries far less leverage than most of its peers, and the MLP made a wise decision several months ago to slow distribution growth and fund more its growth initiatives with retained earnings.
And regarding EPD’s attractiveness relative to bonds, the numbers speak for themselves. Today, EPD shares yield 6.3%, more than double the yield on the 10-year U.S. Treasury (2.9% at time of writing).
Furthermore, I think it is highly likely that bond yields have peaked for the foreseeable future. With the Federal Reserve dampening the economy with rate hikes and with inflation still mostly at bay, there is no obvious catalyst to send bond yields higher. Interestingly, Morgan Stanley would seem to agree with me. On June 24, the bank’s head of interest rate strategy announced his view that yields had peaked for the year.
That remains to be seen, of course. But even if yields do go a little higher from here, EPD’s yield remains very compelling.
EPD’s 6% year-to-date return can appear deceptive, as this year has been anything but a steady and smooth ride. The stock enjoyed a nice start to the year but took the February selloff particularly hard, losing nearly 20% of its value. EPD recovered its losses and pushed to new highs in early June before correcting moderately due to trade war fears and an agreement by OPEC to boost production.
It’s an odd market when a company this stable operationally has a stock that is this volatile. But such is the market we’re in.
I can’t say with any confidence that the broader market will be higher by year end … or even that EPD’s share price ends the year higher (though I expect it will). If we get a repeat of February’s volatility, all bets are off.
That said, if you’re looking for a rock-solid income producer that raises its distribution like clockwork, EPD is going to be hard to beat.
As of this writing, Charles Sizemore was long EPD.
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