Are Enterprise Products Partners Fairly Valued?

MarketBeat.com – MarketBeat

Enterprise Products Partners (NYSE: EPD) recently went on a wild ride. It has gone through some amazing highs and lows and is up 7.82% so far. As a result, investors may wonder if the current share price is a good entry point to buy shares.

So let’s look at the bull and bear case for investing in EPD to see if we can figure out its valuation.

The Bull Case

Wall Street’s opinion of a particular stock is a good starting point to investigate whether it is potentially undervalued. According to the MarketBeat consensus awardt of $30.50, EPD has a potential benefit of 24.95%. In addition, eleven analysts rated the stock and came to the consensus that it was a mediocre buy.

Other aspects of EPD’s fundamentals are also substantial, including the fact that some insiders have bought stocks and the low short-interest ratio. Insiders bought $248,000 worth of stock last quarter and it has a short interest ratio of 1.63%.

Then there is the macroeconomic background of the SPD, which has improved significantly since the start of the war in Ukraine and especially with the termination of Nord Stream 1 output to Europe by Russia. In July, the International Monetary Fund (IMF) wrote that Russia’s halting of natural gas supplies to this region means that Europe’s economic output could fall by as much as 6 percent.

This means alternative hydrocarbon suppliers such as EPD are about to see an increase in demand in the region to help make up for the shortfall. And as geopolitical tensions between Russia, China and NATO countries continue to escalate, Western-focused energy companies are likely to benefit from favoritism as strong tailwinds.

The Bear Case

Some weaknesses in the basic principles and background of the EPD need to be explored.

The first is the dividend, often cited as one of the main draws for buying stocks. EPD has raised its dividend for 24 consecutive years and is on track to become a dividend aristocrat.

However, the problem lies in the dividend coverage ratio, which currently stands at 81.90%. This means that the company pays out a significant amount and a portion of its net profit in dividends to shareholders, which is probably unsustainable under normal operating conditions.

EPD could cut its dividend in the coming years, putting an end to its dividend growth. One plausible proposition, however, is that the company will redirect some of its dividend income toward scaling up its capital expenditures, which could lead to greater returns for shareholders down the line. This would mean that EPD could further tap into a number of opportunities, including the gas shortage in Europe.

Another catalyst is the global energy transition to renewable energy sources, which will be facilitated primarily by a rising demand for hydrocarbon products. These are solid reasons for EPD to consider shifting its spending to infrastructure due to a rapidly increasing overall addressable market for its output.

The final reason is that natural gas does not fit into the renewable energy paradigm and will eventually be replaced by cleaner and more efficient energy sources, such as green hydrogen and nuclear fusion. This means that while natural gas supplies such as EPD could rise over the next decade, they only provide a temporary solution to reduce carbon emissions. Their preference may decline rapidly as better energy technologies develop.

The question is then a potential benefit over the long-term and opportunity cost. In other words, are investors better off paying a premium for natural gas stocks to potentially get faster returns, or are they investing where the energy market is ultimately going at a lower price?

For example, uranium stocks generally have lower valuation ratios than natural gas stocks, and hydrogen stocks can also be picked up relatively cheaply. Investors waiting for these decades-long deadlines for hydrogen and uranium supplies to take off are also taking on more risk, which is always a factor to consider.

It comes down to

EPD has the momentum to continue its rally in the near term, and in the medium term it will benefit from some solid catalysts in its macroeconomic context. However, investors should also consider their investment horizon and risk tolerance, as natural gas is not the intended solution to the world’s energy needs. There are cheaper stocks that fit this solution that may have greater (and also more speculative) upside potential than gas stocks like EPD.