"The first law of capital allocation - whether the money is slated for acquisitions or share repurchases - is that what is smart at one price is dumb at another." - Warren Buffett
Let's face it, no stock is always a good buy or sell. There are periods where it is a good buy and periods where it is a good sell. The trick, as we all know, is to be on the right side of the trade at the "right time."
While you can never be 100% sure of the right time, one indicator we like to monitor that can be a useful signal is a company's share buyback. When companies decide that shares of their stock represent a smart investment at current valuations, the board will sometimes approve and initiate a stock buyback program. This is often a bullish signal for two reasons:
- It's a vote of confidence that can affect price sentiment and momentum. Like insider stock purchases, company buybacks often provide insight into senior management's "true" sentiment on current price to value. This in turn can affect investor sentiment, putting a stronger floor under a stock and affecting price momentum.
- It reduces share count which can improve EPS and price. Stock prices are usually driven over time by earnings performance. Decreasing shares is often one of the easier ways for management to increase earnings and consequently price per share over time.
It's no coincidence buybacks are a favorite tool of the activist investors and have been very popular this year. More often than not, the activist investor is looking to optimize return on investment over the short to medium term (1-3 years). The activist investor and boards use the monetary and market sentiment powers of buybacks to optimize shareholder value, and unlike dividends or other forms of investor remuneration, buybacks usually allow for optimal long-term capital gains tax treatment (assuming one holds the stock for a year).
All of this is not to say that stock buybacks are always positive or lead to good things; like most things in life, there are pros and cons to the stock buyback, but often it can provide insight into management's price/value sentiment, and act as a good entry point signal.
With the power of the stock buyback in mind as a possible signal of value, or entry point indicator, let's look at today's buyback candidate, Energy Transfer Equity (ETE).
ETE just announced a $1 billion stock buyback program on Dec. 23, 2013. Interestingly, ETE's buyback does not come on the heels of poor stock performance (which is often the case with buybacks), but rather after exceptional 2013 performance.
Oil & Gas Industry Stock Performance Post Buybacks in 2013
Before we take a closer look at ETE, let's look at some of the other energy companies that have initiated stock buybacks this year, and how they have fared post buyback announcement. Other notable energy companies that have implemented stock buyback programs in 2013 include; Halliburton (HAL), Schlumberger (SLB), Marathon Petroleum (MPC), Marathon Oil (MRO), Phillips 66 (PSX) and Hess (HES). Below is a chart that tracks the performance of four of these stocks (randomly selected) post stock buyback announcement. Interestingly none of the stocks had long or significant price retreats (post announcement) under the price of the stock on the date of buyback announcement, and all are currently above that price today. While this is not always the case with buybacks, it does illustrate buybacks may help support price floors and appreciation and provide a useful stock entry data point.
Energy Transfer Equity, L.P. is part of the energy sector in the Oil & Gas industry. ETE is a master limited partnership (MLP) which owns the general partner and 100% of the incentive distribution rights (IDRs) of Energy Transfer Partners, L.P. (NYSE: ETP), approximately 49.6 million ETP common units, and approximately 50.2 million ETP Class H Units, which track 50% of the underlying economics of the general partner interest and the IDRs of Sunoco Logistics Partners L.P. (NYSE: SXL). ETE also owns the general partner and 100% of the IDRs of Regency Energy Partners LP (NYSE: RGP) and approximately 26.3 million RGP common units. The Energy Transfer family of companies owns more than 56,000 miles of natural gas, natural gas liquids, refined products, and crude oil pipelines.
ETE's price has performed exceptionally well during 2013, appreciating some ~80%, and has also shown consistent, stable growth over the past 5 years as illustrated in the chart above.
The ETE "Story"
Every stock has a story that lays out the "potential" or where it's hopefully going. So what's ETE's "story"? In the past year, ETE and ETP have collectively transformed from natural gas and NGL carriers into a national, diversified energy partnership with accelerating revenue growth and widening margins. ETE's lower-risk General Partner business plan now has a stronger structure and more focused effort on cash flows, growing investor return and optimizing investor value. A few of the recent and coming catalysts to support continued payout growth, stock price stability/appreciation and optimized investor value:
- Recent Acquisition: Regency Energy Partners' (which is part of the ETE family of MLPs) recent acquisition of Eagle Rock (EROC), which RGP expects will be accretive to cash flow and potentially generate a 6%-8% increase in distributions this year.
- Commitment to Increased Payout and Growth Through Further Aggressive Acquisitions: Management is committed to continue to build assets and returns via focused acquisition activity with numerous irons in the fire.
- Stock Split and Repurchase Plan: In addition to the benefits of a repurchase plan (as stated above), ETE will be implementing a stock split to shareholders of record on January 13, and there is some historical evidence that stock splits can also have a significant and positive impact on a stock's future price performance.
For a deeper dive on the ETE "story" and catalysts, check out Energy Transfer Validates Bulls...
The Market Sentiment
Have you ever seen the movie Limitless, where Bradley Cooper, who plays the main character, takes a drug that makes him a genius and proceeds to rack up huge gains in the market very quickly. When asked how he beats the market, he talks about algorithms related to "market sentiment" (if my memory serves). The reality is sentiment is what drives price. We've all seen those seemingly undervalued stocks that had little interest (positive sentiment) and languished with no price movement, and those seemingly overpriced stocks that continued to rise based on little more than dreams of "potential" or rumors. Sentiment, whether driven by fundamentals, dreams or something else, trumps everything when it comes to the current price movement of a stock. So what seems to be the state of sentiment for ETE?
- Investor Sentiment: ETE has a very positive recent growth trend indicating positive investor sentiment, with a price that currently reflects a 13% increase over the 50-day MA and a 29% increase over the 200 day MA.
- Analyst Sentiment: Analyst consensus has an "Outperform" on ETE with a mean rating of 1.62, indicating a somewhat positive outlook/sentiment.
- Insider Sentiment: There has been little in insider selling or buying over the last 6 months, indicating neither positive nor negative sentiment.
- Company Sentiment: The company's recent buyback program, while not huge in size ($1 billion) relative to market cap, does indicate a positive current price sentiment.
While the stock performance has been exceptional during 2013 and consistent over the past five years, the fundamentals alone can be a bit misleading and don't necessarily scream undervalued or buy. A quick snapshot of some of the key metrics: Earnings History: Top line earnings growth has been exceptional and consistently beat estimates over the last 8 quarters, while bottom line earnings has been somewhat erratic, missing 5 of last 8 quarters. High-growth companies can exhibit this characteristic. Debt: $22 billion in long-term debt, $300 million in short-term debt with a debt/equity close to 16. Very leveraged, though oil and gas pipeline stocks are "real asset" companies and they can have huge leverage on their balance sheet, especially when in heavy growth phases. Question is, are cash flow streams stable/growing and do they justify/support debt levels. Revenue Growth: 515%, PE: 55. Forward PE: 30, ROE: 92%, 5 YR. PEG: 2.5. P/B: 16.46. Yield: 3.29. P/S: 4.925.
ETE has had a great run over the past year and has been quite consistent over the past 5 years. While debt is significant, and the recent run and fundamentals may give one pause from a pure current value standpoint, the bigger "Bull" story, potential catalysts, aggressive growth trajectory, market sentiment, price history and commitment to investor payout certainly make the stock worthy of deep consideration for those who seek a combination of income and growth.
Note: The Value of the Stock Buyback as an Entry Point Indicator
As stated, buyback is no guarantee of future success (just like insider transactions) and there will always be bull/bear dissent among stock investors, but the buyback can help create pricing floors, affect investor sentiment and move prices. And one thing always holds true, those on the inside are privy to things those on the outside can't see and it's always wise to give extra attention and weight when those on the inside give their opinion or guidance, which is exactly what a stock buyback really is!
Disclaimer: This article is for informational, educational and/or entertainment purposes, and is based on the author's personal thoughts, opinions, views and ideas only. Nothing in this article should be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security. All data and information provided was collected in best effort and there is no express or implied warranty as to the accuracy of any data or information provided.