Energy Transfer: Debt Reduction & Dividend Growth Make It Attractive

Investment Rationale

Energy Transfer’s (NYSE:ET) stock has fetched handsome returns for its investors in 2022. Along with attractive price returns, the company also offers a handsome dividend yield. The company is expected to benefit from the rising ethane prices owing to its acquisitions and new projects that increased its ethane export capabilities. The company’s financial statements also show strength with sufficient cash flows and a healthy balance sheet. These factors, along with the ET stock’s attractive valuation, make it a suitable candidate for long-term investment.

About the Company

Energy Transfer provides energy-related services through its export terminals and around 120,000 miles of pipelines. The company’s core operations include transportation, storage, and terminaling of natural gas, crude oil, NGLs, and refined products. The company primarily carries on its activities in the US and Canada. Energy Transfer also has investments in other businesses like Sunoco LP (SUN) and USA Compression Partners (USAC), which are publicly traded master limited partnerships.

Strong operational performance in 2021

Over years, the net income, revenue, and free cash flows generated by Energy Transfer have shown an upward trend .

The return on equity, return on capital employed, and return on invested capital have recovered strongly after the 2020 dip.

Energy Transfer has a lower EV to Free Cash Flow ratio, which evaluates the company’s ability to pay back the cost of its acquisition or generate cash for reinvestment in the business. The lower the ratio, the faster the company can pay the acquisition cost. As Energy Transfer is an active company in the Mergers and Acquisitions market, this ratio proves to be useful while analyzing the company. The company’s EV to Free Cash flow ratio has decreased over the last three years and is also lower than Williams Companies (WMB), ONEOK Inc (OKE), and Kinder Morgan (KMI), which is a positive sign.

In the last three years, the company’s free cash flows were higher as compared to the dividends paid.

Strong Q32022 results

Energy Transfer reported impressive Q32022 results. The company’s adjusted EBITDA grew despite the impacts of charges relating to legal matters in the crude oil transportation and services segment and negative adjustments related to hedged inventory. The adjusted distributable cash flow attributable to partners stood at $3.09 billion as compared to $2.58 billion reported for Q3 2021, an increase of around 20%. The quarterly cash distribution announced by the company zoomed around 70% on a YoY basis. With the distribution increases, the company took a step forward in returning additional value to shareholders. Simultaneously, the company aims to maintain its target leverage ratio between 4.0x to 4.5x.

In Q32022, the company invested $500 million in growth capex. According to the management’s commentary in the Q32022 press release, 90% of the company’s growth capital is attributed to ongoing and expected projects promising some attractive cash flows before the end of 2023.

Focus on repayment of debt

On the balance sheet, Energy Transfer shows a declining debt number in the past three years as well as in the first nine months of 2022. This shows the company’s focus on the repayment of debt. During Q32022, the company executed the sale of its 51% interest in Energy Transfer Canada ULC. This sale fetched the company cash proceeds of around $302 million. This corporate action has further given a good opportunity to the company to de-lever its balance sheet and invest capital in new projects.

In December 2022, the company issued a $1 billion aggregate principal amount of 5.55% senior notes due in 2028 and a $1.5 billion aggregate principal amount of 5.75% senior notes due in 2033. The company plans to use the proceeds from this offering to reduce debt.

If we consider Energy Transfer’s debt to EBITDA ratio on a TTM basis, it has been decreasing in the past three years and is one of the lowest among its peer companies. The company aims to strategize its cash flow in a manner that will help to improve its financial base to invest in high-return growth projects. Energy Transfer also has a total available liquidity under its revolving credit facility of around $2.32 billion as on September 30, 2022, implying a good capacity leftover from its revolver credit facility.

Growth Projects

Energy Transfer has some exciting projects upcoming, including –

• The Gulf Run Pipeline project was placed into service in December. It would deliver domestically produced natural gas from key producing regions in the U.S. to cater to the increasing demand across the Gulf Coast and international markets.
• The Grey Wolf Processing Plant, located in Delaware Basin, with a capacity of 200MMcf/d of natural gas.
• The company will start soon the construction of the Bear Processing Plant in the Permian Basin. The company plans to put the plant into service by 2023 to fulfill the growing demand.
• The company added Frac VIII to expand the total fractionation capacity at Mont Belvieu.
• The recent LPG expansion projects at the Nederland facility have paved the way for the export of more than 700,000 barrels per day of NGLs from its Nederland Terminal.
• Additional 20-year LNG SPA (Sale & Purchase Agreement) with Shell NA LNG LLC. With this, the company has entered into a total of six long-term LNG SPA.

Leading among peers

ET stock has outperformed its peer companies in terms of price return and total return. Additionally, the dividend yield offered by the company is also the highest among peers.

The stock offers an attractive dividend yield. Based on the forward EV-to-EBITDA ratio and price-to-free cash flow ratio, ET stock trades at an attractive valuation compared to its peers.

Growth Drivers

The following aspects can be identified as the key drivers for Energy Transfers’ future growth-

• Energy Transfer has a diversified customer base across markets, commodities, and geographies and also has access to large customers. To elaborate more, through the crude oil segment, the company gets substantial access to the Permian, Bakken, and Midcon Basins whereas the NGL and refined products segment has more than 60 facilities connected to the company’s NGL pipelines. The company’s natural gas intrastate pipeline is the largest in the U.S. with interconnects to Texas markets.

• Since the Energy Transfer Partners-Energy Transfer Equity merger in 2018, the cost of capital for the company has largely been reducing. A reduced cost of capital indicates better funding available for the company to invest in new projects.
• The company’s ownership structure shows a good balance of management and insiders with shareholders. The company has a significant presence of retail and institutional shareholders which indicates a healthy ownership structure.

• Energy Transfer has projects which export a substantial amount of ethane. The rejection or recovery of ethane depends on the prevailing ethane prices in a particular region. In the current energy market, ethane prices have been on a rising path. Energy transfer expects the growing ethane demand should boost recovery. According to an EIA report “Demand for ethane overseas as a petrochemical feedstock has been growing since 2015. We forecast U.S. exports of ethane to continue to grow from about 350,000 b/d in the second quarter of 2022 to about 440,000 b/d in the fourth quarter. We expect ethane exports to rise to 460,000 b/d in 2023.”

Risks

Since its inception in 1996, Energy Transfer has been an active company in the mergers and acquisition space. Though this seems as a positive point for the company’s growth, a risk persists that the company may overpay for its growth.

Another risk can be seen with the rising EPC costs for LNG project developers. Energy Transfer needs to focus on the reduction of these costs as it would be difficult to pass on these higher costs to its customers due to the prevailing stiff competition.

Conclusion

Energy Transfer has a diversified earnings base which primarily consists of fee-based contracts. The company has an attractive percentage of capital invested in ongoing as well as upcoming projects which gives clear revenue visibility. It is also generating substantial free cash flows to support the return of capital to its shareholders. The company’s emphasis on the repayment of debt is a positive sign for investors. Additionally, its attractive valuation, high dividend yield, strong assets base, and prevailing opportunities relating to ethane exports add to the attractiveness of ET stock.