JamesBrey
An ideal retirement passive income vehicle is one that offers very attractive current income, which will not only be sustainable over the long term but also continue to grow at a rate that meets or even beats inflation over the long term. As a result, it will not just sustain, but potentially even improve an investor’s purchasing power without having to buy additional shares or units in that passive income vehicle.
However, for a company to be able to do this over the long term, it needs to have a durable and defensive business model that can weather macroeconomic, geopolitical, and technological disruptions. It also needs to have a strong balance sheet so that it never faces the choice between shoring up its balance sheet and continuing to pay out its distribution. Additionally, it needs to have a reasonably conservative payout ratio, providing a margin of safety so that it never has to weaken its balance sheet further to continue paying out its distribution. It should also retain enough cash flow to reinvest in growing and strengthening its business to set it up for long-term durability and growth.
Today, we will discuss two midstream MLPs that pass these passive income machine tests with flying colors: Enterprise Products Partners (NYSE:EPD) and MPLX (MPLX).
Business Models
EPD’s business model is both defensive and durable. It generates the vast majority of its cash flow from assets that have lengthy contracts on them, making them largely resistant to commodity prices. Additionally, it has significant geographical and asset diversity within the midstream sector and its fully integrated business model gives it access to numerous major producing basins that it can then aggregate and transport to various end markets such as international exports, petrochemicals, and refiners.
In particular, EPD has a very strong position within the natural gas liquids space and a well-positioned petrochemical business. It is also investing aggressively in growing its asset portfolio, with $6.9 billion worth of growth capital projects under construction. These include major NGL pipelines and export facilities, a product system, Permian gathering and processing enhancements, and NGL take-away capabilities. EPD is also working to leverage existing infrastructure to improve its fractionation integration and sees numerous additional growth possibilities in its ethylene and propylene system expansion, liquid hydrocarbon exports, pipelines, processing, and product transformation businesses. It also expects the AI boom to increase natural gas demand, further enhancing its business model.
Meanwhile, MPLX boasts a steadily growing logistics and storage segment as well as a growing gathering and processing segment. It owns refining, gathering, and processing assets in the Appalachian region that are largely tied to capacity and minimum volume contracts, providing it with very stable cash flows through various economic and energy market cycles. MPLX is also continuing to invest in growth projects, particularly in the Permian Basin and other strategic pipeline projects, such as a recent joint venture that combines the Whistler and Rio Bravo pipeline assets. Additionally, it is reducing capital expenditures to increase free cash flow and maximize its distribution growth and unit repurchases.
One important item to note is that MPLX is controlled by Marathon Petroleum (MPC), which prioritizes distribution growth for MPLX since MPC benefits considerably from the large distributions. While the relationship is mostly symbiotic, there are times when interests may conflict, as seen with the Andeavor Logistics deal, which was slightly value-destructive for MPLX unit holders. However, over time, MPLX has delivered very attractive returns for investors, indicating that overall, MPC is doing a good job of generating value for MPLX unitholders through its management of the MLP.
Balance Sheets
When it comes to their balance sheets, both EPD and MPLX are in strong shape. EPD is in particularly strong shape, with its sector-leading A- credit rating from S&P. A significant 98% of its debt is fixed rate, and it has an impressive 18.8-year weighted average term to maturity on its debt. Notably, 81% of its debt matures in 10 years or later, with 48% maturing in 30 years or later. Additionally, 87% of it matures in five years or later, giving it a very low interest rate risk. Last, but not least, EPD also has $4.5 billion of liquidity and a very low leverage ratio of only 3.0 times.
MPLX also has a strong balance sheet, with its steadily falling leverage ratio in recent years from nearly 4.0 times in 2020 to now sitting at 3.2 times in Q1 2024. It also has well-balanced debt maturities, with between $1 and $2 billion worth of debt maturing just about every year between now and 2030. Given that it generated over $5.2 billion in distributable cash flow in fiscal 2023, it is well-positioned to handle these maturities with internal cash flow if it chose not to refinance them. While this would certainly eat into its ability to invest in growth, buy back units, and grow its distribution if it followed that course, the flexibility means its balance sheet is strong. Combined with its stable business model, MPLX is at low risk of having to cut its distribution.
Distribution Outlooks
When it comes to distribution coverage, EPD has a roughly 1.7 times distributable cash flow coverage ratio of its distribution, giving it plenty of flexibility to retain cash flow to invest in growing the business with little to no risk of having to cut its distribution in the near term. MPLX also has a conservative coverage ratio of 1.55 times expected in 2024. While not as conservative as EPD’s, it is still plenty conservative, especially given its less aggressive CapEx budget compared to EPD.
In terms of their growth outlooks moving forward, MPLX is expected to grow at a slightly slower pace than EPD. Its revenue is actually expected to shrink by a 0.2% CAGR through 2028, whereas EPD is expected to grow at a 1.6% CAGR. On a distributable cash flow per unit basis, EPD is expected to grow at a 5.6% CAGR, whereas MPLX is expected to grow at a 4.9% CAGR. This is not surprising given that EPD is retaining more cash flow and is investing more aggressively in growth projects, while MPLX is focusing more on share/unit repurchases.
Meanwhile, MPLX is expected to continue growing its distribution at a slightly faster pace than EPD, likely growing its distribution at a 5.5% CAGR, whereas EPD is expected to grow its distribution at a 5.1% CAGR moving forward. Given that EPD is investing more aggressively in growth projects, while MPLX is freeing up more cash flow to return to unit holders, this makes sense. However, once EPD’s substantial growth projects come online in the coming years, it will have a lot more cash flow available for discretionary spending. Its leverage ratio will drop significantly with the additional EBITDA coming online, and it will also have less CapEx spending. As a result, it would not be surprising if EPD either does a major buyback at that point, aggressively accelerates its distribution growth, or potentially even issues a special distribution.
Valuations & Investor Takeaway
When it comes to valuation, EPD is slightly cheaper than MPLX with a 9.5 times EV/EBITDA versus a 9.7 times EV/EBITDA for MPLX. On a distribution yield basis, MPLX does have a higher yield at 8.5% compared to EPD’s 7.2%, which makes sense given that it has a lower distribution coverage ratio. On a price-to-expected-distributable-cash-flow-per-unit basis for 2024, EPD currently trades at an 8.2 times multiple, whereas MPLX trades at a 7.8 times multiple, making MPLX a little bit cheaper on that basis. However, this also makes sense given that MPLX has a bit more leverage than EPD, which can result in a higher yield on distributable cash flow, even though its EV/EBITDA is slightly higher.
On a historical average basis, EPD trades at a slight discount to its five-year average with a 9.5 times current EV/EBITDA compared to its 9.6 times five-year average. MPLX trades at a 9.7 times EV/EBITDA compared to its five-year average of 9.1 times, making it appear a bit overvalued on that basis. Still, with its very attractive and well-covered distribution yield and solid growth outlook, MPLX appears likely to generate double-digit annualized total returns moving forward, even if its EV/EBITDA multiple were to contract a little bit. As a result, we still rate MPLX a buy. EPD also earns a buy rating for many of the same reasons, though it has less risk of valuation multiple contraction and a stronger balance sheet. Its overall business model also makes it a lower-risk investment. EPD offers similar long-term total return potential as MPLX does, but has a lower risk profile, giving it superior risk-reward. As a result, we favor EPD over MPLX, especially as a lower-risk passive income vehicle, but we rate both as buys right now.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
