- 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%!
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.
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.
This article was written by
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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.