- ETP delivered a strong quarter and delivered a strong distribution coverage ratio of 1.36x, which gives ETP the flexibility to further increase the payout.
- Strength was across the board as capacity increases led to higher transportation volumes, and growing production will increase volumes in coming quarters.
- Under $60, units offer a solid 6.6% distribution yield with upside potential as ETP gradually increases the distribution.
On Tuesday, Energy Transfer Partners (NYSE:ETP) delivered strong quarterly results that justified an earlier 5% year-over-year hike to the quarterly distribution. With its current $0.935 quarterly payout, ETP yields a solid 6.6% yield. Given its strong coverage ratio, more hikes are likely in ETP's future. Units were mildly higher after-hours, and I expect ETP to eventually get past $60 thanks to strong growth prospects and a solid yield as the company benefits from the US energy boom with its midstream natural gas assets. Should the US become a player in exporting liquefied natural gas ("NGL"), Energy Transfer would see even more demand for its pipeline network, helping to push that distribution higher. Alongside Enterprise Products (NYSE:EPD), Plains All American (NYSE:PAA), and Kinder Morgan Energy Partners (NYSE:KMP), ETP is a great holding for income-oriented investors who want to profit from growing US energy production.
In the quarter, ETP earned $0.69 on revenue of $12.23 billion, which was up 12.7% year over year (all financial and operating data available here). For comparison, analysts were only looking for $0.63 on sales of $12.09 billion. For MLPs, investors tend to focus on distributable cash flow ("DCF") rather than earnings as this figure determines what a sustainable distribution is. DCF is modified free cash flow as it is operating cash flow less sustaining capital expenditures. Growth cap-ex is not deducted. In a sense, DCF is sustaining free cash flow. In the quarter, DCF was $629 million, compared to $376 million last year.
On a per unit basis, DCF was $1.93 compared to $1.25 last year. Investors should note that the unit count increased year over year to 325.5 million from 301.8 million. As the company returns the vast majority of cash flow to investors, growth projects are funded with debt and equity, necessitating the issuance of units. This does make DCF/unit growth slower than DCF growth, though the growth was still substantial. Importantly, the coverage ratio was 1.36x compared to 0.9x last year. A coverage ratio of 1x means that the company distributes as much cash as it brings in. When the coverage ratio is less than 1x, a distribution may not be sustainable because the company generated less than it paid out.
Importantly in this quarter, ETP generated cash in excess of the distribution with a very strong coverage ratio. ETP has about $166 million in excess cash, which it can use to help fund growth projects or increase the distribution. If ETP can maintain this type of performance, it can easily afford a distribution in excess of $1.00. The strength was pretty much across the board as just about every unit improved on last year's results as adjusted EBITDA came in at $1.2 billion compared to $956 million last year.
Thanks to investments in the Eagle Ford shale, Midstream gathering volumes increased by about 9% with increased capacity at Eagle Ford generating $34 million in revenue. NGL transportation was even stronger with transportation volume increasing 52% to 418,000 barrels per day. This powered a 60% increase in adjusted EBITDA at the unit. These gains were primarily thanks to the expansion of the pipeline out of West Texas. If the US begins to seriously export LNG in the coming 3-5 years, ETP is well positioned to transport LNG towards the Gulf of Mexico. Combined, interstate and intrastate transportation were roughly flat, though operating efficiencies helped to increase adjusted EBITDA by over 10%. ETP's investment in Sunoco Logistics was the lone weak spot as lower crude prices put a pressure on margins.
During the quarter, the company spent $718 million on growth capital expenditures in the quarter, and for the full year, ETP anticipates maintaining a similar pace with cap-ex focused on its midstream and Sunoco divisions. The excess cash it generated during the quarter can help fund these growth projects, helping to cut the required issuance of debt and equity. ETP has long-term debt of $16.2 billion against $15.2 billion of equity. This is an appropriate amount of leverage given ETP's stable, fee-based business. I expect ETP to fund growth with a roughly equal amount of equity and debt in coming quarters to maintain the integrity of its balance sheet.
On the whole, this was a pretty strong quarter for Energy Transfer. Stronger volumes thanks to expanded capacity helped to push DCF appreciably higher and contributed to a robust 1.36x coverage ratio. With improving volumes out of West Texas and Eagle Ford, we should see strong DCF coverage for the balance of the year, which could lead to another distribution increase. ETP could comfortably raise the payout to $1.00 and still generate excess cash to help fund its growth projects. ETP will also be a beneficiary of US LNG exports given its extensive transportation network. Units currently yield 6.65%, and I expect the distribution to continue to grow. Under $60, ETP is an attractive income investment with upside potential.