Although Energy Transfer Partners (ETP) posted weak third-quarter results chiefly because of the dismal natural gas market, we believe the partnership has made sound strategic moves in the energy sphere and seems well-poised to increase its distributions in the near future. The merger with Sunoco Inc will prove to be the right catalyst for the partnership's success and we hold that the current undervaluation in the market provides the right time to make an entry.
ETP announced its third-quarter results on November 7, highlighting an increase of $77.5 million in adjusted EBITDA YoY amounting to $481 million. Distributable cash flows also increased by $73.4 million and stood at $339.5 million. The overall financial health of ETP was impacted by the citrus dropdown, the completion of its propane operations of AmeriGas Partners (APU), the repayment of its outstanding debt and the sale of the ETC Canyon Pipeline for approximately $270 million. ETP, however, reported a loss of $0.33 per limited partner unit against $0.19 for the same quarter a year ago. The lackluster market conditions in the natural gas space and depressed margins in the Intrastate Transportation and Storage segment have contributed towards the relatively weak performance.
Distributions of 89.375 cents per unit were announced last month to unit-holders as of November 6, 2012 and were paid on November 14.
Previously we highlighted that one of the concerns among investors was the fact that ETP has not increased its distributions for the past four years. The primary reason has been its focus on achieving organic growth to diversify away from the natural gas business and into oil. Beginning in 2010, many of the projects have centered on achieving a cash-flow mix which will provide stability in the revenue stream and consequently more predictable and higher cash flows. The fee-based system ensures that the distributions are minimally exposed to the risk of volatile commodity prices.
For example, the merger with Sunoco Inc for which an approval was won in October was driven by a commitment to expand into the crude oil transportation business. The move was deemed important in light of the depressed natural gas prices which have adversely impacted the business. Sunoco shareholders were provided with the option of getting $25 cash payment and 0.5245 ETP units or $50 in cash.
The deal will allow ETP to gain control of the 8,000 miles of Sunoco's pipeline and as many as 4,900 gas stations. Moreover, ETP will have ownership of SUN's branded retail business, general-partner interest and a stake (32.4%) and distribution rights in Sunoco Logistics Partners L.P (SXL). This way ETP can achieve a 70 % cash-flow mix from natural gas and 30 % from hydrocarbons such as crude oil and refined products.
We maintain our initial investment thesis although investors are growing impatient with the unwillingness of ETP to increase its distributions. The Sunoco deal will provide the partnership with the right mix of exposure to generate higher and more predictable cash flows. However, this can only come about if the acquired assets are successfully integrated into the business.
Kinder Morgan Partners (KMP)
Magellan Midstream Partners L.P (MMP)
NuStar Energy L.P (NS)
Spectra Energy Partners L.P (SEP)
Enterprise Products Partners L.P (EPD)
ETP has a debt/equity ratio of 125%, interest coverage of 2.5x and cash from operations (TTM) of $1.25 billion. Currently, ETP trades at an EV/EBITDA multiple of 12x and given the fact that the SUN deal provides ETP with the much-needed diversification and potential higher distributable cash flows in the future, we believe the units are undervalued in the market. As seen from the table above, ETP is trading at a 25% discount to its competitors EV/EBITDA multiple.
Apart from the diversification into the crude-oil transportation business, the recent merger also widens ETP's geographical reach into northeast America where ETP previously did not have any presence. 33% is the expected contribution from the Sunoco merger to the cash flows in the future. This is a very good entry point for long term investors as the units are trading near their 52-week lows of $40 and we believe that ETP has made all the right moves in executing its long-term strategy to bring more predictability and improvement in its business plan.