Enterprise Products Partners (NYSE: EPD) is the largest master limited partnership (MLP) by far, with more than double the market capitalization of the second-largest MLP, Energy Transfer Partners (NYSE: ETP). Enterprise Products has extensive assets in most of the important oil and gas-producing regions of the country:

Source: Enterprise Products Partners

As a result, analysts closely follow the partnership’s earnings calls to gauge the health of the entire midstream energy sector. Last week Enterprise hosted an earnings call after reporting third-quarter results, and here are some highlights.

Net income for the third quarter was down relative to a year ago — $658 million compared to $699 million for the third quarter of 2014 — but the partnership reported a 13% increase in liquid transportation volumes to a record 5.9 million barrels per day (bpd). Liquid volumes transported increased for crude oil (+21% to a record 1.5 million bpd), refined products and petrochemical volumes (+12% to a record 904,000 bpd) and natural gas liquids (NGL) (+10% to a record 3.2 million bpd). The NGL transportation volumes included a 33% increase in LPG export volumes to a record 320,000 barrels a day.  

Even though third-quarter income was $0.32 per unit compared with $0.37 per unit for the third quarter of 2014, Enterprise Products generated $970 million of distributable cash flow. This was sufficient for 1.3x distribution coverage and the 45th consecutive quarterly distribution increase. The annualized yield based on the announced distribution of $0.385 per unit is 5.6%.

Note that even though year-over year income only dropped by 13.5%, EPD units have been hit as hard as the shares of many oil producers. For the past 12 months, EPD has a total return of -25.1%, worse than the Energy Select Sector SPDR ETF (XLE), which is down 20.4% over the past year. Conservative investors looking to add exposure to the energy sector should take note of this opportunity.

The role of incentive distribution rights (IDRs) in the relationship between limited partners (LPs) and a general partner (GP) has been the topic of a great deal of discussion over the years. The idea is that by paying the GP a growing portion of the distribution, there is a greater incentive for the GP to grow the partnership’s distribution as quickly as is practical. EPD CEO Michael Creel left no doubt where he stands on the matter when he noted what would have happened had EPD’s IDRs not been eliminated in 2010:

“Enterprise would have paid more than $6 billion to its general partner under the IDR since the fourth quarter of 2010 and our distribution this quarter would be 0.7 times instead of 1.3 times, and that assumes that we would have the same growth trajectory, the same cash distribution and the same credit ratings and that’s a big assumption.”

Creel was skeptical that a potential change in IRS regulations could hurt the business, “Certainly to the extent that the IRS has expanded the scope of qualifying income over time, they may be trying to change that, but when they start trying to change the original legislation, that seems to be problematic. The end result is we don’t think there is going to be any significant impact on us.”

Creel also stressed the importance of the Permian Basin to the partnership, noting that some 30% of all U.S. rigs are now deployed there. EPD is building two new processing plants and adding to its takeaway capacity for natural gas liquids in the region.

Acknowledging the tough operating environment, Chief Operating Officer James Teague said that the partnership’s focus has shifted from moving greater volumes to moving volumes more efficiently. He further noted that “all indications are that demand is responding to low prices; a trend that we believe will continue in 2016 and one that will help the global oversupply situation that began in 2014.” Teague said Enterprise Products is driven to find “the opportunities that are invariably created during chaos” — which is good all around advice for energy investors in this market.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Targa Merger Claims Another MLP       

Targa Resources (NYSE: TRGP) borrowed a page from Richard Kinder’s playbook in arranging to buy out its MLP affiliate Targa Resource Partners (NYSE: NGLS) in an all-equity deal that will trigger deferred tax obligations for the MLP’s limited partners.

The deal is a distribution saver, with Targa exchanging TRGP shares yielding 6.8% after today’s drop of nearly 8% for NGLS units yielding 10.4% even after today’s 4% price bump.

The 18% premium based on the two securities’ prices on the eve of the announcement was strictly notional, if only because NGLS has twice the market capitalization of TRGP. And even if realized it would not have offset the tax hit for long-term NGLS limited partners.

The merged TRGP, in contrast, will benefit from an enlarged tax shield on its dividends, which is still expected to increase 15% next year, followed by 7% in 2017 and 10% in 2018, all with surplus cash flow coverage the standalone NGLS lacked, according to Targa’s new projections.

While the reduced distribution yield will certainly pinch investor incomes, it should also help curb equity issuance and inspire greater confidence that the dividend and the financing model are sustainable.

We’re maintaining our Buy rating on TRGP as well as NGLS in the Growth Portfolio. Buy TRGP below $75 and NGLS below $40.

Course Correction at Navios

Longtime underperformer Navios Maritime Partners (NYSE: NMM) lowered its yield by the simpler but more painful means of slashing its istribution by more than half, from an annualized $1.77 per unit to the new target of 85 cents per unit.

Management, which had previously pledged to hold the distribution steady through 2016, blamed its change of heart on “significant uncertainty relating to global trade, with deepening uncertainty about prices of most seaborne commodities and continued questions relating to the outlook on seaborne volumes and ton miles.” It then threw in “ the continued digestion of the oversupply of dry bulk vessels and a difficult financing market” for good measure.

The unit price was recently down 16%, which stings. In the silver linings department, this does reset a dividend long described here as unsustainable and discounted accordingly by the market. The new reduced distribution left NMM with a 1.69x third-quarter coverage ratio; its ships are 99% booked for the remainder of the year, with 63% charter coverage for 2016 and 45% for 2017.

The fleet’s daily time charter equivalent rate has held steady this year and the reduced distribution still works out to 14.2% at a unit price of $6. Investors who’ve held on this long would be unwise to sell here. We’re lowering the Buy limit on Aggressive recommendation NMM to $8 in recognition of its reduced means and limited near-term upside, however. 

— Igor Greenwald