Energy Transfer: A 9% Yielder That's Growing And Safe

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About: Energy Transfer LP (ET)
by: Value Kicker
Summary

ET is yielding a high 9% yield with good growth potential.

Going through Moody's methodology, we can see that ET has a relatively safe profile.

ET has a lot of growth projects in the pipeline justifying its high leverage ratios.

In my research on MLP's as investments, I always try to seek potential mispricing. So, stumbling upon Energy Transfer (ET) piqued my curiosity. The company is one of the larger MLPs and has a fat dividend yield of 9%. So, what could be causing this mispricing? For one, the company had a relatively complex structure that it had attempted to simplify in recent years. The most recent was a merger, completed in the latter half of 2018, between Energy Transfer Equity and Energy Transfer Partners (ET is the remaining entity) in order to strengthen the overall company's finances and remove expensive incentive distribution rights. Investors may still view the company with a certain amount trepidation especially since a past merger in 2016 of two of ET's subsidiaries burned investors with a "stealth distribution cut". However, it is in my view that the "clean-up" of ET's structure should be largely completed, which would give us investors the chance to fully evaluate the company's intrinsic value moving forward. As discussed in my previous articles on MLPs (here and here), I use Moody's methodology to go through the various key points when evaluating an MLP.

Source: Moody's Midstream Energy Rating Methodology Moody's Corporation (Registration required)

Background

ET is one of America's largest energy companies with assets reaching coast-to-coast, covering 38 states. The company's core operations include transportation, storage, and terminal for natural gas, crude oil, NGLs, refined products, and liquid natural gas. The company also recently opened an international office in Beijing to meet the growing demand for ethane and liquid natural gas products and to better leverage the increasing business opportunities in the exportation of energy products to China and other Asian markets.

Source: ET investor presentation August 2019

ET benefits from massive scale

Scale is the first factor evaluated in Moody's methodology and is deemed to be important as the size of an MLP is correlated to the safety and stability of the distributions paid.

Size typically plays an important role in gauging the credit strength of a midstream company, because it influences many of the core attributes that drive its resiliency to stress. These attributes may include, among other aspects, operational and financial flexibility, economies of scale, and the breadth of a company's product and service offerings, customers and market reach. Operations of larger midstream companies tend to weather temporary disruptions better, owing to a generally broader mix of product and service offerings, geographical spread and exposure to producing basins

Source: Moody's Midstream Energy Rating Methodology Moody's Corporation

Moody's evaluates Scale in two ways 1) Based on Net PPE and 2) based on EBITDA. Reviewing the company's latest financials, we can see that ET has a Net PP&E of $67 billion and $68 billion (in 2018 and 2019 respectively) and an EBITDA of $8.6 billion and $10.1 billion (in 2018 and annualized 2019, respectively), giving it a score of Aaa for both factors.

Source: Moody's Midstream Energy Rating Methodology Moody's Corporation

ET has a well-diversified business

ET benefits from one of the largest portfolios of assets with exceptional product and geographic diversity. The partnership's multiple segments generate high-quality, balanced earnings with no single segment contributing more than 30 percent of the partnership's consolidated Adjusted EBITDA.

The majority of the partnership's segment margins are fee-based and, therefore, have limited commodity price sensitivity. According to the Moody's methodology, the business profile of an MLP is correlated to the safety and stability of its distributions. Along the Midstream Energy value chain, certain types of businesses carry higher risks. Different types of business operations within the midstream sector are affected by varying degrees of business risk. While ET operates in a lower risk portion of the industry and benefits from product and geographic diversity, I couldn't find any disclosures in the company's most recent 10-K on the average length of its contracts. Without knowing this information, I would have to give the company a score of A to Baa.

Source: ET investor presentation August 2019

Source: Moody's Midstream Energy Rating Methodology Moody's Corporation

ET has a high debt leverage ratio

In the MLP space when evaluating distributions, leverage and coverage measures are important indicators of a company's financial flexibility and long-term viability. This is evaluated by looking at the EBITDA/Interest Expense, Debt/EBITDA ratios and (FFO - Maintenance Capex)/Distributions. Using the available company data and disclosed information, we can forecast these ratios for 2019 to be 8.7, 4.6, and 1.8, respectively. Based on Moody's methodology, ET has a Baa rating on EBITDA/Interest Expense ratio a Ba rating on Debt/EBITDA ratio and a Baa rating for (FFO - Maintenance Capex)/Distributions.

Source: Author's calculations

ET does not have the best financial ratios. However, in terms of pursuing growth opportunities, it is pretty aggressive. The company intends to spend between $4.6 billion and $4.8 billion in capital projects in 2019, a large bulk of it is in natural gas liquids transportation and services. Given that the company recently opened an office in Beijing, this leads me to believe that they are seeking to rapidly grow their export capability.

Source: ET Second Quarter 2019 10-Q

Source: ET investor presentation August 2019

Conclusion

Going through each of Moody's factors, we arrive at a final score for ET at 7.5, indicating a Moody's rating of Baa. Looking at the scorecard, the company doesn't do well in its financial metrics. However, given the scale and diversity of the business itself, it offsets these factors. In other words, the company's business is safe enough to warrant its higher leverage ratios. Using this additional amount of debt, the company is pursuing growth opportunities to grow distributions even further. I think investors are sleeping on this stock, given that the company is yielding a nice big 9% yield, pursuing growth opportunities aggressively and is relatively safe. This is a buy for me and a solid income addition to any portfolio.

Source: Author's calculations

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ET over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don't know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.