One of the most interesting developments of the past week that a lot of investors probably didn’t pay a lot of attention to is the widening spread between U.S. (WTI) and Middle Eastern (Brent) crude oil. WTI, short for West Texas Intermediate, typically trades at a discount of a few dollars per barrel compared to Brent crude, but over the last week that spread has increased to a little over $11 per barrel. The last time that kind of spread happened was 2015, and prior to that it was 2011. The rarity of such a discrepancy is a big part of what opens up an opportunity for investors who are paying attention.
I think a lot of stock investors miss these kinds of anomalies is because of the fact that it reflects most directly on the commodities themselves. Unless you are actively involved in trading commodities futures, you might not think too much about the price of a barrel of oil except in relation to how its impacts the price you pay at the pump for gasoline. So how does this translate to something a stock investor can use to guide an investment decision?
A wider-than-normal spread between these two competing commodities can be caused by a lot of different things, but it usually implies some kind of negative pressure on U.S. producers. I this particular case, the spread appears to be a reflection of the reality that U.S. producers have been increasing production consistently for quite some time now, to the point that U.S. transport infrastructure – pipelines and storage facilities, in particular – to handle the supply is almost uniformly already running at full capacity. That means that producers can either scale back production, or find other transportation methods, such as truck and railroad transport, which are more expensive than pipelines. Either way, the pressure is on producers, while pipeline and storage companies are working as hard as they can to bring new capacity online.
The problem is that new pipelines and storage facilities take time to build and get up and running. An increasing number of experts think that the current capacity limitations will persist through 2019, which means that U.S. crude prices could see limited upside potential on that commodity for the foreseeable future. On the other hand, pipeline and transportation companies are in a advantageous position, since they can charge a higher premium to those producers. Oil refiners are also in a good spot, since the bigger spread means that they can buy U.S. crude at a deeper discount, which naturally improves their profitability potential.
There are a number of stocks that could be in prime position to see great upside due to the factors I’ve just outlined, but the stock I’m highlighting today, EPD is one that also has a good fundamental and technical basis that bolsters that forecast even more. Let’s take a look.
Fundamental and Value Profile
Enterprise Products Partners L.P. (EPD) is a provider of midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, petrochemicals and refined products in North America. The Company’s segments include NGL Pipelines & Services; Crude Oil Pipelines & Services; Natural Gas Pipelines & Services, and Petrochemical & Refined Products Services. The Company’s midstream energy operations include natural gas gathering, treating, processing, transportation and storage; NGL transportation, fractionation, storage, and import and export terminals, including liquefied petroleum gas (LPG); crude oil gathering, transportation, storage and terminals; petrochemical and refined products transportation, storage, export and import terminals, and related services, and a marine transportation business that operates primarily on the United States inland and Intracoastal Waterway systems. EPD has a current market cap of $63.8 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings grew by a little more than 8%, while sales grew more than 27%.
- Free Cash Flow: Over the last twelve months, Free Cash Flow has declined modestly, but remains solid at about $1.4 billion as of the company’s most recent earnings statement.
- Debt to Equity: the company’s debt increased by about 10% over the last year, but is manageable, as their operating profits are more than sufficient to service their debt.
- Dividend: EPD pays an annual dividend of $1.71 per share, which translates to an annual yield of more than 5% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods uses the stock’s Book Value, which for EPD is $10.63 per share. At the stock’s current price, that translates to a Price/Book Ratio of 2.76. The stock’s historical Price/Book Ratio is 3.4, which is 23% above its current level. If the stock rallied to par with that historical average, its price would be $36 per share, a level the stock last saw late in 2014.
EPD has been hovering in a relatively narrow range for most of the past two years, but I think the economic factors I’ve already outlined could act as a catalyst to drive the stock out of that pattern. Here’s a look at the stock’s latest technical chart.
EPD 5-year candlestick chart
- Current Price Action: The chart above covers a five-year period because I want you to think about this stock’s potential beyond the limits of its range over the past couple of years. A lot of investors tend to think only about 52-week high or low ranges, but when you see that the stock’s actual high in late 2014 was around $41, the fact that the stock is now pushing near to a 52-week high seems less formidable.
- Trends: We tend to think about stock trends only in upward or downward terms, and in that context the stock’s short-term upward trend since April of this year is a positive. I’ve used the horizontal red and green lines on the chart to illustrate the stock’s actual long-term trend, which in real terms can only be considered sideways. The stock is at the upper limit of its 2-year range, and that does mean that the stock could break down and drop back down toward the $24 price range it last saw two months ago. On the other hand, a break above that red resistance line, to the $30 level should give the stock the momentum to drive to between $34.50 and $35 in the near-term, and if the trend holds, it wouldn’t be surprising to see the stock test its multi-year high around $41. That is, admittedly, a best-case scenario, but it also offers a long-term price target nearly 40% above the stock’s current level.
- Near-term Keys: Watch the stock’s movement between its current level and $30. A break above $30 is a prime opportunity to go long, while a break back down below $29 could offer a good bearish-oriented trade, either by shorting the stock or by buying put options.