Business context and reporting period
Enterprise Products Partners L.P. (NYSE: EPD) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2019. The partnership provides North American midstream energy services across NGL, crude oil, natural gas, petrochemical and refined-products businesses. It reports four segments: NGL Pipelines & Services; Crude Oil Pipelines & Services; Natural Gas Pipelines & Services; and Petrochemical & Refined Products Services. Unless noted, amounts below are in U.S. dollars.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $8.28 billion | $8.47 billion | $16.82 billion | $17.77 billion |
| Operating income | $1.56 billion | $986 million | $3.19 billion | $2.12 billion |
| Net income attributable to limited partners | $1.21 billion | $674 million | $2.48 billion | $1.57 billion |
| Basic and diluted earnings per unit | $0.55 | $0.31 | $1.12 | $0.72 |
| Non-GAAP distributable cash flow (DCF) | $1.72 billion | $1.42 billion | $3.35 billion | $2.81 billion |
| DCF distribution coverage | 1.8x | 1.5x | 1.7x | 1.5x |
Q2 operating margin was approximately 18.9% of revenue, compared with 11.6% a year earlier. This comparison was materially affected by volatile commodity-derivative mark-to-market results, especially in the crude oil segment; it should not be read as a purely underlying operating trend. Management’s non-GAAP total gross operating margin was $2.08 billion for Q2 versus $1.48 billion, and $4.21 billion for the first half versus $3.06 billion.
- Cash flow and investment: First-half operating cash flow was $3.18 billion, versus $2.70 billion. Investing activities used $2.29 billion, including $2.26 billion of capital expenditures; financing activities used $1.20 billion. Management-reported non-GAAP free cash flow was $950 million for the first half.
- Balance sheet and debt: At June 30, cash was $107 million; total assets were $58.72 billion; total equity was $24.98 billion. Debt principal was $27.12 billion, up from $26.42 billion at December 31, 2018. Balance-sheet long-term debt was $26.39 billion, with $500 million classified as current maturities.
- Liquidity: Management reported $4.68 billion of consolidated liquidity at June 30, comprising $4.57 billion of available revolving-credit capacity and $107 million of unrestricted cash. The partnership stated it was in compliance with debt covenants.
- Distributions and units: The Board declared a Q2 distribution of $0.4400 per unit, up 2.3% from Q2 2018, payable in August 2019. Management’s stated 2019 distribution expectation was $1.7650 per unit, subject to Board approval. EPD repurchased 2.91 million units for $81 million in the first half under its $2.0 billion multi-year buyback authorization.
Material changes versus the prior comparable period
- Revenue fell 2.3% in Q2 and 5.3% for the first half, largely reflecting lower marketing revenue and commodity prices. Lower cost of sales more than offset the revenue declines, contributing to higher reported operating income and earnings.
- Q2 crude oil segment gross operating margin increased to $513 million from $53 million; first-half margin rose to $1.18 billion from $273 million. A major driver was the swing in non-cash Midland-to-ECHO 1 mark-to-market results: a $14 million gain in Q2 2019 versus a $310 million loss in Q2 2018, and an $81 million gain for the first half versus a $424 million loss.
- Midstream service revenue increased $88 million in Q2 and $203 million in the first half. Management cited strong Texas pipeline demand, new or expanded assets, and higher storage, fractionation and terminal activity. Crude-oil and petrochemical/refined-products marketing revenue declined in the first half.
- First-half equity income from unconsolidated affiliates increased to $292 million from $238 million, mainly reflecting higher earnings from crude oil pipeline investments. Interest expense rose to $567 million from $527 million, primarily because average debt balances were higher.
- Cash distributions paid to limited partners were $1.91 billion for the first half, compared with $1.85 billion. First-half capital expenditures increased to $2.26 billion from $1.92 billion.
Outlook, management commentary, risks and unusual items
- Capital plan: Management forecast approximately $4.4 billion of 2019 capital investments: $4.0 billion for growth and $350 million for sustaining projects. It cited about $6 billion of growth projects scheduled for completion by the end of 2020. These forecasts depend on operating cash flow and access to debt, equity and other funding, and may change.
- Projects and subsequent events: In July 2019, EPO issued $2.5 billion of senior notes due 2029 and 2050, at fixed rates of 3.125% and 4.20%, respectively; proceeds were intended for debt repayment and general purposes, including growth investment. Also in July, Enterprise announced Chevron agreements supporting development of the proposed SPOT offshore crude export terminal, subject to permits, and crude pipeline expansions expected to enter service in 2020. Altus exercised an option for a 33% interest in the Shin Oak NGL pipeline, generating $441 million for Enterprise after quarter-end.
- Liquidity Option: The liability was $474 million at June 30, compared with $390 million at year-end. The partnership recognized $84 million of first-half non-cash expense from accretion and valuation changes, primarily reflecting a lower discount rate. The holder may exercise the option to sell OTA to Enterprise during a 90-day period beginning February 1, 2020; the transaction would involve acquiring OTA’s EPD units and assuming associated tax obligations.
- Commitments and market exposure: Estimated long-term NGL purchase obligations totaled $13.0 billion, up from $10.8 billion at year-end, including $3.6 billion of new commitments entered into during the first half. Results remain exposed to commodity prices, supply and demand, customer performance, interest rates, and derivative valuation and settlement timing. Management stated it uses hedging and fee-based contracts to manage, but not eliminate, these exposures.
- Legal and regulatory matters: The Energy Transfer litigation remained pending before the Texas Supreme Court, with oral argument scheduled for October 2019; management recorded no provision because it did not consider payment probable. The partnership also described ongoing PDH-project litigation against its former contractor. An EPA notice of violation concerning Baton Rouge facilities could lead to sanctions exceeding $0.1 million, which management did not expect to be material.
- Other unusual items: Q1 Houston Ship Channel disruptions reduced gross operating margin by an estimated $40 million, substantially recovered in Q2 as delayed shipments were rescheduled. The partnership adopted lease accounting guidance effective January 1, 2019, recognizing $246 million of operating-lease right-of-use assets and liabilities at adoption. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Most important facts for investors to verify
- How much of the earnings and gross-margin improvement reflects sustainable volumes and fees versus non-cash commodity mark-to-market reversals, especially in crude oil.
- Whether 2019 capital spending, planned 2020 project start dates, and associated funding remain consistent with the stated plan.
- Debt levels, the use of July 2019 note proceeds, near-term maturities and credit-facility renewal; also assess liquidity against the partnership’s substantial capital and purchase commitments.
- The sustainability of DCF coverage and the declared distribution, including the effects of growth investment, buybacks and the shift to open-market units for DRIP and EUPP obligations.
- Developments in the February 2020 Liquidity Option, the Energy Transfer and PDH litigation, and the EPA matter.