Energy Transfer: Taking Advantage Of The Sell Off, But With Caution

Summary

• Oil is in free fall along with the markets.
• Energy Transfer was hard hit, falling almost 30% during 'Black Monday'
• The distribution yield has exceeded 15%. The thesis remains intact.
• I took advantage of the sell off, lowering my average price to just below $9.
• The worst may not be behind us. Spread your buys over time.

Coronavirus fears in conjunction with oil turmoil has been an explosive combination, rattling financial markets. Following the abrupt withdrawal of Russia from OPEC+ talks, we got an even more surprising move from Saudi Arabia over the weekend, sparking a price war. Instead of an output reduction, we are now facing substantial output increases. Oil crashed. At some point, it was down as much as 30%. In the end, it plunged 24% marking the the worst day since 1991, hitting multi-year lows. Many argue that this oil crash is different (Russia is trying to harm the US shale producers, Saudi Arabia is trying to impose it dominance on Russia, etc - there are too many moving parts. The bullish thesis is that Russia will reach out to Saudi Arabia for a deal. In any case, we have experienced two massive oil crashes within a 5 year period. To be fair, energy never properly recovered following the 2015/16 crash.

The market is in panic mode. For example, Occidental Petroleum (OXY) fell more than 50%!

Source: Seeking Alpha

Even the mighty BP PLC (BP) and Exxon Mobil (XOM) fell by 19.1% and 12.2%, respectively. These are massive drops.

Energy Transfer (NYSE:ET) was not spared, falling almost 30%. I believe that the current valuation represents exceptional value and I am taking advantage of these prices, averaging down.

Source: Seeking Alpha

Besides the massive drop in the oil price, which affects sentiment, not much has changed with ET since my previous article. My core thesis remains intact and it is important to note that the vast majority of ET's revenue backlog is fee-based and not a function of oil prices. At yesterday's closing unit price of $7.37, the dividend yield exceeds 16%. I more than doubled down my position during the 'Black Monday' sell off, bringing my average price to just under $9. I am willing to keep on averaging down until this drama ends, but it might take time. It is also important to note that in February the CEO Kelcy Warren paid $45.2M for 3.6M units at an average price of $12.53 (more than 50% higher versus today's price!), lifting his overall ownership to 255.6M units.

At this point, it is important to highlight the key element underpinning my long thesis. Each quarter ET is left with more than $700M after distribution payments (around $3Bn annually). This provides tremendous financial flexibility and a reasonable path towards deleveraging. What's more, even though 2020 expected growth capital is still elevated (~$3.9-$4.1Bn), the long-term expected capex run-rate is ~$2.0-$2.5Bn per annum. This should result in positive free cash flow starting in 2021, which is a major milestone for ET and sets the foundation for superior returns over time. Lets not forget what a long way ET has gone, shifting away from the traditional MLP model which relied upon ongoing share capital increases with very tight distribution coverage ratios. The distribution coverage ratio for FY 2019 was a healthy 1.96 times.

ET is getting closer and closer to achieving a 100% self-funded model. For those who are not familiar with my strict investment criteria, I believe the following model, which has served me well over a prolonged period of time, is a recipe for success.

Stable (and ideally growing) cash from operations is sufficient to cover all of the following corporate priorities:

• returning capital to shareholders in the form of buybacks and/or dividends
• maintenance CAPEX in order to sustain the existing level of operations (i.e. sustain current revenues and profitability)
• growth CAPEX - innovation, investing in and acquiring other companies
• balance sheet improvements such as increasing the cash balance, paying down debt, etc

As mentioned above, it is likely that ET will reach self-funded status, and is on a path of generating surplus cash after distributions and capex. As such, I see the current period of turmoil as an opportunity to accumulate ET units on the cheap. The 'end game' is to end up with a full size position at a very attractive average price, and that is why I am averaging down now, in times of panic. You cannot time the optimal entry point. It is important to note that the worst might not be behind us yet. The impact of the coronavirus is still a question mark. There are too many unknowns. I am putting money to work now, but with caution. I wouldn't be surprised if the market falls a lot more from here.If it does, this could mean a unit price below $5 for a short period of time until we see concrete signs that the worst is behind us.

Analyst’s Disclosure: I am/we are long ET. 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.

Comments

[Michael1944]

I own DHT,Tankers are doing well.
Most like TNK or EUNAV.

[georgefelix75]

Kelcy is one of the least trusted CEO;s in the space so I'm wondering with his buying up all this stock what is the worst scenario end game here?

[CincinnatiRick]

@georgefelix75 Kelcy has always been into empire building rather than milking a cash cow. If you invest with him, resign yourself to the fact that you are simply along for the ride. I'm sure he'd be willing to buy any shares you might want to sell at this price. And, on the other hand, if you do not sell, you are right to be concerned as to a possible "worst scenario end game." That apparition is probably making some contribution, unfortunately immeasurable, to the current swoon in the market price.

[Justanalysis]

Whatever he does will significantly impact his management team as well as his directors. They own like 4% compared to his 10-11%. What's the upside for them? I'm sure they don't have as deep pockets.

[Financial Man]

The time to buy stocks is when there is financial blood in the streets. Now is not the time to sell solid investments with good dividend yields. Even if ET were to cut it divided in half, it would still offer a good return. Let me know when the US runs out of a need for natural gas to heat our homes, water heaters, stoves, blast furnaces, etc. In the meantime, enjoy the cheap price of energy and do not rush out to buy an electric vehicle.

[Michael1944]

The world soon will be oversupplied.all storage facilities will be full,companies losing money just to stay afloat.
The U.S Oil Industry needs to shut down completely,start again when Saudi Spat is over, along with the Wu Flue.

[rwingjr]

Oh yeah, that will really show them and do wonders for the US economy. /s SMH

[ChuckXX]

Regarding "ET" and the authors quote of "The distribution coverage ratio for FY2019 was a healthy 1.96 times". Well with the stock right now trading at $4.01 then I would think everybody including the AUTHOR of the article should be backing the truck up and loading up big time.

[aretailguy]

@ChuckXX -He is a writer, not an investor....

[georgefelix75]

@ChuckXX I understand the midstream space has sold off but ET with all the bullishness etc has done just the opposite. Its definitely not acting well in here......like another shoe to drop?

[crrj]

Need a good lawyer to sue this board for not controlling the managements or their risky ways----and for selling their business fraudulently as simply low risk/fee-based -----its farthest from truth---they are at risk for their risky drilling customers----- unreal

uninvestable proved again

[wpmorrison]

The real question with ET is will they be around in 2021? The stock is by far one of the worst performers in the energy sector and I'm sure Kelsey is out looking at who he can buy. This stock has gone nowhere except down in the past three years. Time to exit the train wreck?

[Joe de Mencia]

here are their bonds, you tell me: www.boerse-berlin.com/...

[Financial Man]

The time to buy stocks is when there is financial blood in the streets. Now is not the time to sell solid investments with good dividend yields. Even is ET were to cut it divided in half, it would still offer a good return. Let me know when the US runs out of a need for natural gas to heat our homes, water heaters, stoves, blast furnaces, etc. In the meantime, enjoy the cheap price of energy and do not rush out to buy an electric vehicle.

[Idkmuch]

et was 6 or less during 2016, whats going on now is way more of a problem than 2016, no way to dice it

[iel76]

Actually traded at $4 intraday in that timeframe

[Idkmuch]

these all goign lower, except for hope a recovery this hasnt cascaded yet

[arcticfoxman]

If I was CEO I'd definitely stop expansion and cut Capex while the oil price appears to be a long term low. Next I'd cut the dividend and immediately afterwards buy back units. I don't mean slash dividends but enough to yield 7.5% at current price. That's just the sensible thing to do for the company. Won't help me as that won't of course be 7.5% on my book cost but it's what I'd do as a cold management strategy through the next nasty year.

[cyrus trask]

Artic Fox, you evidently have a lot more common sense that the present CEO has.
Cut growth projects, reduce debt, and buy back shares. It is obvious what should be done.

[Hanger]

They all need to get Debt/Ebitda to below 3x. That is the prudent and sustainable capital structure.

[Uncle Ted]

ET needs to get leverage at least below 3.5 similar to EPD. ASAP .Then it will have value . Kelsy' still has a lot of "wildcatter" in his view of the energy market . He must become Conservative, improve ROI, reduce leverage, increase free cash flow all of which will drive price higher.

[crrj]

Let it hit $4--then the company can announce a take-private deal at $12---and be done with it.

KMI CEO seems to have bought another 500K shares---lets go Kelcy--- where your money vs mouth homey? IF--big IF its truly a deal :)

[FTTH investment guru]

exactly what Kelcy would love to do and I wouldn't be surprised at all

[cyrus trask]

it's there dude. Will it go to 2?

[eaglesail]

There is currrently no was to price risk

[rutzga]

With a yield of 20%, ET is suffering from an "it's too good to be safe" profile. Although it was very encouraging to see the insiders at much higher prices, the uncertainty of whether of not ET can maintain the dividend based on volumes transported in the future has made everyone step back. Yet, at some point, averaging down is an exercise of calculated risk. Is it possible for ET may decrease its dividend by, say 50%? Possible (IMO, not probable), but a yield of 10% at these current prices married with a rebound in the oil markets within the next six months, and ET would give a patient investor an average annual total return of 50% plus over the next two years. And this "eyeball" analysis is assuming a 50% dividend reduction. Anything less than a 50% and you are looking at an even better total return. One could argue that a dividend reduction announcement after some clarity in the immediate future in the oil markets would generate a stock price rally in ET from the price today--as the market would interpret the proactive conservation of capital as a relief that the a bigger dividend cut was not deemed necessary.

[Justanalysis]

So how is Kelcy going to explain to investors that he still brought in $8 billion operating cash flow but cut the dividend. Using the decline in the stock price to cut a dividend is not really a very good reason. Cash flow would have to decline by $2 billion just to justify cutting a dividend. (assuming he keeps on using $4 billion for debt repayment and cap ex). What's he going to do with the extra $2 billion? The pipelines are not variable fees, they are committed fees and the oil and gas, if not taken, then becomes an imbalance, but the E&P still has to pay for the gas and oil. Helps to have been an Energy research analyst for almost 25 years. So let's theorize that some E&P's go BK and can't pay. ET management said somewhere (earnings call?) that 90% of their customers are investment grade. So, if 10% of cash flows go BK, that's only $0.80b lost. Where do you lose the other $1.2b? Well, the BK companies assets are then liquidated. Guess who has priority in payment? Pipelines are first, according to the courts. You don't want a bunch of pipelines cutting off payment. What about big companies just not taking their oil or gas committments? Yes, it happens every day. That's why they keep ledgers called imbalance reports. But they still have to pay for their committments. Go back to the late 80's when a few big boys decided not to pay and told their pipelines, and other creditors with take or pay arrangements to pound sand. Guess what, they all lost in court, granted it took almost 10 years in some cases, but they got interest less fees. Some of them got a really bad rap for doing that, so I'd struggle to think they would do it again. But most of those management teams were kids on the school yard when that happened. Perhaps they don't know the lessons learned. Anyhow, I think the risk is pretty low there is not much of that. Putin bit off more than he can chew to get back at Trump for not approving his own pipeline. So Putin thinks he can kill off shale with a price war. He has his hands full now with a price war with the Saudi's. Most of this is drama. Keep an eye on the numbers. Numbers don't lie, unless you fudge them of course, but that's why we have auditors.

[Justanalysis]

Your next question is likely, then why is everyone dumping the stock. Some have requirments of their plans not to have this on their books if it drops below a certain amount or risk profile. Obviously companies don't hold these, but hedge funds and others have to dump. Some big holders, like Nuveen may dump just to preserve cash, even if temporarily. They aren't required to ride it down and back up.

[Hanger]

Wouldn't it be reasonable to cut some dividends, use that cash to reduce debt to keep leverage ratios below 5x?

[stevenljc]

Every day someone writes I bought at 9
I bought at 8 7 6. Is 2 next for this garbage. I luckily sold at 12. But I’m still holding mpc and bkr. Getting slaughtered

[Zeebala]

I can't agree with you more. I have been averaging down with ET and also CNXM and two REITS-NRZ and ABR. I'm in it for the long run.

[vovc]

dividend cut?

[rob123]

How does ET compare with ENBL? Long term.

[magichr]

I got it at 6 bucks today got my price point down under 8. i don't know how people avoid buying at these lows.

[Idkmuch]

@magichr the debt worries people including prefferen and kicker you get kelecey so itll be lower in this environment

im suprised its at 6

[User 4376541]

They avoid buying because just maybe this is not a good time to buy. There are such good opportunities out there that far surpasses this questionable equity.

[Clark158f1]

ET is priced as if it was going bankrupt. A true steal in my opinion as it is a survivor in this world of panic selling.

[Sundance kid]

Maybe we get to the point where Treasury starts paying a person for owning the stocks? :)))))