Energy Transfer - Dividend Risk Masks Financial Strength

Summary

• Energy Transfer has an impressive portfolio of assets. The company has some dividend risk from a potential rating downgrade.
• However, the company's overall financial strength and cash flow is impressive and that's the money that will keep being available for shareholders.
• Energy Transfer is moving towards FCF positive. That means that the current time is the bottom of the company's financial position, and things will only improve from here.
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Energy Transfer (NYSE: NYSE:ET) is one of the largest midstream companies with a market capitalization of more than $20 billion and a double-digit dividend yield. The company has recovered significantly since its 52-week lows, however, despite that it has significant potential to go and offers shareholders a great potential return.

Energy Transfer - Hunt, Guillot & Associates

Energy Transfer First Quarter Results

Energy Transfer showed its ability to generate significant shareholder returns with its 1Q 2020 results, along with its ability to handle the downturn.

Energy Transfer 1Q 2020 Results - Energy Transfer Investor Presentation

Energy Transfer recorded record volumes moved as a midstream company, which is what truly matters, versus prevailing market prices. The company continued to focus on its core businesses and recently placed the Panther 2 Processing Plant and Frac 7 into service. The company's massive investments over the past few years and new projects will help to support more cash flow.

Financially, the company saw adjusted EBITDA of $2.64 billion and $1.42 billion in DCF. That came with a 1.72x DCF coverage ratio and $1 billion in growth capital. The company managed to achieve nearly $600 million in DCF in excess of contributions, however, due to capital spending, it still had to borrow $400 million.

The company has cut its capital spending recently to be roughly $3.6 billion for 2020. That means the company has roughly $850 million in remaining quarterly capital spending. That means the company's borrowings on a quarterly basis will be much lower. Going into 2021, the company is looking at more like $500 million in quarterly capital spending.

That means the company should be capital spending positive. Additionally, the company has a strong strategic and liquidity position. The company has recently completed a strong midstream acquisition and has respectable growth potential going forward. We will expand on the company's strong liquidity position later on.

Energy Transfer Cash Generation and Outlook

Energy Transfer is forecasting continued strength of the remainder of the year, although things won't be perfect.

Energy Transfer 2020E EBITDA - Energy Transfer Investor Presentation

Energy Transfer expects 2020E EBITDA of ~$10.7 billion. The company is expecting the drop in EBITDA from lower prices, but going forward, it's quarterly EBITDA is expected by the company to be at least the same level as 1Q 2020 or higher. That potential for continued strength in EBITDA will mean continued cash flow.

The company still has roughly 92.5% fee based capital and sees commodity and spread risk to be ~7.5% total. That's totally manageable by the company and can be more than covered by the company's cost cutting initiatives from a profit standpoint. The company is continuing to take additional steps to improve its portfolio but cash generation should remain secure.

Energy Transfer Capital Spending

At the same time, it's important to realize that the company is still spending a double-digit % of its market capitalization on capital projects that will provide long-term growth.

Energy Transfer Capital Spending - Energy Transfer Investor Presentation

Energy Transfer is spending a significant amount of capital, even as they work to wind it down. The company has cut 2020E growth capital to ~$3.6 billion and is evaluating another ~$350 million cut for 2020. Given the credit rating risk the company faces, which we'll discuss later, we feel it's imperative that the company moves forward with that.

Past that, the company expects annual capital spending at under $2 billion enabling the company to have positive FCF starting in 2021. This highlights the company's cash flow generating strength. Not only can the company spend nearly 10% of its market capitalization annually on growth, but it can continue paying out its double-digit dividend an be cash flow positive.

That highlights the strength of its cash flow abilities. The company's continued focus on growth projects will mean steady growth as it pays a strong dividend.

Energy Transfer Financial Position

Fundamentally, Energy Transfer has a strong financial position to support the company as it moves towards being FCF positive.

Energy Transfer Financial Position - Energy Transfer Investor Presentation

Energy Transfer has minimal debt due over the coming years meaning the company can avoid rolling over debt and focus on paying off that debt and growth. The company, in Jan. 2020, completed an incredibly well timed offering of debt at a great interest rate, and there's no reason why as the market recovers, the capital markets won't reopen for the company.

More importantly, the company has been able to use preferred units, as a hybrid debt and equity structure, to decrease the amount of "debt" from the perspective of ratings agencies. As the company continues investing in growth, which'll improve its EBITDA and debt positioning, along with moving towards being FCF positive its financial position should only improve.

Energy Transfer Shareholder Rewards

Energy Transfer is focused on putting this all together into shareholder rewards.

Energy Transfer Dividend History - NASDAQ

Energy Transfer has a long history of paying its dividends out. The company hasn't increased its dividend in some time as a result of the oil price collapse, however, over the past nearly 2 years, the company has continued to pay its dividend of $1.22 annualized. That's a dividend yield of more than 13% and it's one that the company can continue to pay with a manageable $3.3 billion / year.

Personally, at a double-digit dividend risk, we would like to see the company look at share buybacks, even instead of dividends. However, it's clear that shareholders are invested in this stock for its dividend.

Energy Transfer Insider Ownership - Energy Transfer Investor Presentation

Energy Transfer has 14.5% insider ownership, with the CEO and other major members of the company consistently buying more units. In 2020, despite the volatility and uncertainty in the company, major members of the company purchased 0.5% of the overall company. That's a major amount of buying during the time, and it shows insiders have strong faith in the company.

Energy Transfer Risk

In our view, as COVID-19 is solved, Energy Transfer's risk isn't volatility in oil prices anymore so much as it's the S&P's recent announcement of a potential downgrade in the company's credit rating.

The reason this is so significant is because it would knock Energy Transfer from an investment grade credit rating into a non investment grade credit rating. Energy Transfer, despite its strong financial position, still has a significant amount of debt. As a result, management won't let the company that credit rating.

Realistically, it doesn't seem at this time, as the company plans for lower capex in the coming years, that the dividend will be cut. More so, even if the dividend is cut by 50%, it'll be to pay down debt (~$1.6 billion annually) and the company will still provide a high single-digit yield. The cash flow picture won't change, and if the share price drops temporarily, it would be an even better investment.

Conclusion

Energy Transfer has an impressive financial position. The company has continued to balance its FCF position and improved it significantly. The company was FCF negative in 1Q 2020 to the tune of a few hundred $ million. From 2Q-4Q 2020, the company should be much closer to FCF neutral and going into 2021, the company should be FCF positive.

Going forward, Energy Transfer has significant potential. The company is planning to continue investing roughly $2 billion annually (nearly a double-digit % of the company) on the annual growth. At the same time, the company is covering their dividend. They might have to cut their dividend to payoff debt, but the cash flow stays the same.

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.