Since the beginning of 2022, Energy transfer (NYSE:ET)has increased its distribution every quarter. However, not everything went well for the company. In fact, in 2020, the midstream company cut its distribution in half.
So what does Energy Transfer stock and distribution hold for us? First, let’s take a look at what the company does and how it’s growing its distribution.
A giant in the midstream sector
Energy Transfer is an integrated midstream company that transports hydrocarbons such as natural gas, natural gas liquids (NGLs), crude oil and refined products. The company’s operations expand the midstream spectrum, from collection and processing to fractionation, storage and transportation. The company also has interests in a fuel distribution company Sunoco LP And Compression Partners in the United States, which provides natural gas compression services. Energy Transfer is structured as a master limited partnership (MLP), so investors will benefit from K-1 and benefit from unique tax advantages (and obligations).
Approximately 90% of Energy Transfer’s 2024 earnings before interest, taxes, depreciation and amortization (EBITDA) should come from paid activities. Fee-based businesses are not directly affected by commodity price changes or commodity variances and therefore tend to be more consistent and predictable. This is important for income-focused energy investors because it generally means that a midstream company’s distributions are more sustainable.
Energy Transfer’s massive integrated system also allows it to be one of the largest energy arbitrageurs in the United States. The company can take advantage of geographic and seasonal differences to improve both its results and those of its customers. This can be done in several ways, for example by selling natural gas, which has very regional prices, in a market where prices are better, or by storing hydrocarbons to get a better price in the future. It can also transform NGLs into higher value products.
Overall, Energy Transfer is well-positioned to show consistent performance across different commodity cycles, given that it is involved in primarily fee-based businesses and diversified across product types. Its assets also allow it to find the best times and places to sell the hydrocarbons it transports.
Growth Opportunities
Energy Transfer has built one of the largest midstream networks in North America through a combination of organic growth projects and acquisitions.
The company plans to spend between $2 billion and $3 billion annually on growth investments over the next few years. It’s important to note that Energy Transfer can finance these projects solely through the cash flow it generates after paying its distributions. In 2023, it generated $7.6 billion in distributable cash flow and paid nearly $4 billion in distributions to unitholders. This should give it enough room to maneuver for growth projects.
This is important to investors because it allows the company to pay its distributions while still being able to repay its debt. When Energy Transfer reduced its distribution in 2020, it was because its leverage had become too high and it needed to pay down its debt. After reducing its leverage, it was not only able to return its distribution to pre-reduction levels, but its quarterly distribution of 31.5 cents is now higher than the 30.5 cents it was before the distribution reduction .
This year, Energy Transfer plans to spend between $2.4 billion and $2.6 billion on growth projects. Historically, midstream companies have targeted 6-8x growth ROI. So, once completed, these projects are expected to add approximately $350 million in cash flow per year. This growth can then be used to increase its distribution to unitholders.
More benefits to come
Energy Transfer’s distribution is currently well covered by its cash flow, with the company generating free cash flow after distributions of approximately $3.6 billion in 2023. Even with growth capex expected to increase from 1, $6 billion in 2023 to around $2.5 billion this year, its distribution coverage ratio will still be rock solid. With its largely fee-based business model and a strong backlog of growth projects, the company appears poised to continue growing its distribution over the coming years.
ET EV to EBITDA (future) data by Y Charts
On top of that, Energy Transfer is one of the cheapest large-cap stocks in the midstream sector. I generally use an enterprise valueEBITDA multiple to value shares in the intermediate sector. The reason is that enterprise value takes into account things like net debt, while EBITDA excludes non-monetary items like depreciation.
If Energy Transfer were to trade at valuations closer to those of its MLP peers, prices could rise significantly. Today, one of the reasons Energy Transfer has traded at a discount to its peers is that it has not always been the most shareholder-friendly company when its general partner (GP) and limited partner (LP) were trading as two entities, and that the company lost some investors. confidence when he reduced his distribution.
However, Energy Transfer’s GP and LP merged into one company in 2018, eliminating the conflicts of interest that previously existed, and since the distribution reduction in 2020, the company has improved its balance sheet and been able to restore its distribution at its previous level. -cut levels. Although it will take time to restore investor confidence, given its improving balance sheet, growth prospects and current distribution trends, Energy Transfer should be able to win back investors at over time.
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Geoffrey Seiler holds positions in Energy Transfer, Enterprise Products Partners, Sunoco and Western Midstream Partners. The Motley Fool recommends Enterprise Products Partners. The Mad Motley has a disclosure policy.
What’s next for energy transfer stocks and their 8% dividend yield? was originally published by The Motley Fool
