Energy Transfer Partners (ETP) operates one of the largest and the most diversified portfolios of energy assets in the United States. Its natural gas operation includes pipelines for transportation, processing and storage facilities. The company has been doing some major activities recently, including fundraising through a public offering of 13,800,000 common units and utilizing those funds for expansion and acquisition. Moreover, the Internal Revenue Service recently approved ethylene steam crackers as qualified for master-limited-partnership MLP treatment. This has created an opportunity for ETP to get more tax benefits.
However, the company is not yet utilizing its funds to give returns to its shareholders, and the stock has not performed well either - it appears to me to be undervalued. However in the long run, I believe the company will be able to deliver value to investors. Here are some reasons why I think so:
1. Cash usage
By the end of 2012, the company increased its total cash and cash equivalent by more than 200 percent over its previous year's cash level. As per the latest company filings, its cash and cash equivalent figure stood at around $3 billion. Also, the dividend payout trend of the company is more or less constant.
What we can infer from the discussion above are:
- The company, at the moment, does not believe in returning money to its investors, but rather in utilizing it for expansion. Its EPS also jumped 4 times in 2012 over the previous year.
- The company has enough cash to maintain a level of dividend-distribution to its shareholders. Therefore, in the upcoming years, the company is in a position to give at least what it is giving today in terms of dividend.
2. Undervalued Stock
Backed by its inorganic growth, ETP's bottom line has increased by more than 150 percent. It stood at around $15 billion, compared with the 2011 level of around $6 billion. Since the start of the fiscal year 2011, the overall jump in the stock's price was a meager 2%. Although since the beginning of 2013, the stock has jumped about 10 percent, I believe that is way less than its actual potential. The price to book value ratio stands at around 0.9. This shows the stock is undervalued.
3. Strong Expansion Activities
- The company announced that its previously announced public offering of 13,800,000 common units representing limited partner interests at $48.05 per common unit, which includes 1,800,000 common units purchased pursuant to the full exercise of the underwriter's option to purchase additional common units, has closed. Net proceeds from the offering will be used by ETP to repay amounts outstanding under its revolving credit facility and for general partnership purposes.
- In 2012, the company issued $2.0 billion of senior notes and used the proceeds' fund to cash the portion of the acquisition of a 50% interest in Citrus.
- On October 5, 2012, ETP completed its merger with Sunoco. Under the terms of the merger agreement, Sunoco shareholders received a total of approximately 55 million ETP Common Units and approximately $2.6 billion in cash.
4. Opportunity to avail more tax benefits under MLP structure
With the shale production boom in the US, the business of transferring Ethylene and Propylene has increased for players like ETP, Kinder Morgan (KMI and Enbridge (ENB). ETP had entered into a long-term fee-based agreement with multiple producers, including Rosetta Resources Operating LP, SM Energy Co. and a subsidiary of Anadarko Petroleum Corp (APC)., to provide natural gas gathering, processing and liquids services from the Eagle Ford Shale in 2011. Now with the Internal Revenue Service approving ethylene steam crackers as qualified for master-limited-partnership treatment, ETP has a chance to make its MLP structure more valuable and worth more for investors.
As an aside, most readers will know that MLPs have a general partner and limited partners. The general partner manages the operation and individual investors are limited partners. The general partner receives a percentage of the profits off the top, before the limited partners get their cut.
Master Limited Partnerships offer potential tax advantages because most of their distributions are classified as a return of investment instead of income. One doesn't pay taxes on that portion until one sells it. However, after selling, tax will be imposed at the ordinary income rate, not as capital gains.
5. A Strong outlook for the energy transfer industry in the US
U.S. oil production in 2012 is poised to outstrip Saudi Arabia and Russia, returning the U.S. to a position of leadership that it has not held since 1992.
According to the Annual Energy Outlook report of 2013, domestic crude oil increased sharply in AEO2013, with annual growth averaging 234 thousands barrel per day (bpd) through 2019, when production reached 7.5 million bpd.
The growth results largely from a significant increase in the onshore crude oil production, particularly from shale and other tight formations. After about 2020, production will begin declining gradually to 6.1 million bpd in 2040 as producers develop sweet spots first and then move to less productive or less profitable drilling areas.
According to the same report, natural gas use (excluding lease and plant fuel) in the industrial sector increased by 16 percent, from 6.8 trillion cubic feet per year in 2011 to 7.8 trillion cubic feet per year in 2025. Although natural gas will also continue to capture a growing share of the total electricity generation, natural gas consumption by power plants will not increase as sharply as generation, because new plants are very efficient. After accounting for 16 percent of the total generation in 2000, the natural gas share of generation rose to 24 percent in 2010 and is expected to continue increasing to 27 percent in 2020 and 30 percent in 2040.
Here are projected figures for the next 30 years of the total crude oil and natural gas to be produced in the US. This is the scope of ETP's potential market.
So, how is ETP going to be benefited-
- ETP has been able to increase its pipelines all over the major areas of North America to transfer energy resources like crude oil and natural gas to its main markets.
- ETP, being one of the largest and the most diverse amongst all its competitors, can provide energy drilling companies a complete package of offerings.
Area of Concern: Price and fundamentals of competitors, a level yet to be achieved by ETP
ETP faces competition from Kinder Morgan, Inc and Enbridge Inc. Though in terms of market capitalization, ETP is many times bigger than they are, but their fundamentals and stock performance are better than ETP.
Major parameters where ETP needs to improve:
- Price to Earnings ratio of Kinder is 57 and of Enbridge is 111, while ETP is at 10.
- PEG of ETP stands at -1.72 while Kinder and Enbridge have it at 2.04 and 1.96 respectively
- Price to book value ratio of ETP is 0.9 while Kinder has a level of 3.5.
Therefore in terms of fundamentals, ETP has a level far below its actual potential. However, given what I just said about how the company is developing itself, I believe that in a very short time, the company can come up to par.
There is no doubt that the company is expanding very quickly. However the company has not been able to provide the quantum of return an investor expects. I think this underperformance might be for a short period and the company might have bigger plans in the future in terms of expansion. With all the potential I see in the company, I believe that the company and its stock will outperform the market in the long run.