The Market Isn't Recognizing The Value Of Energy Transfer's Preferred Shares

Aug. 31, 2022 6:13 PM ETEnergy Transfer LP (ET), ET.PC, ET.PD, ET.PE189 Comments
Looking For Income profile picture
Looking For Income
121 Followers

Summary

  • All of the NYSE-traded preferred offerings will be repriced or called in the next 24 months.
  • The best-looking investment to me isn't the one with the highest price.
  • The market prices don't seem to be taking into account repricing at higher rates of return.

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adaask

I've been bullish on the common shares of Energy Transfer (NYSE:ET) since 2012. Unfortunately, I've been wrong a good bit of that time. However, early this year, I made a major commitment to ET and placed it as the major holding in my IRA and Roth IRA accounts. Holding MLPs in those accounts exposed them to potential taxes next year. I bought the shares fully aware of that. I did misjudge just how significant that impact could be and how challenging it can be to try to estimate the magnitude of the impact. I was planning to just stay long enough to pick up capital gains and get out of the holding. I was under the mistaken idea that capital gains wouldn't be factored into my potential taxes. I had two quarters of distributions and 13% gains on the sales of the shares. I realized I, or rather my accounts, might have tax issues next year. So, I had to rework my holdings.

What do the numbers say?

Given that I've held ET through both the good and the very long and painful times, I have a reasonable understanding of its business. I started looking at the preferred shares that are traded on the NYSE: Energy Transfer LP 7.375% PFD SR C (NYSE:ET.PC), Energy Transfer LP 7.625% PFD UNIT D (NYSE:ET.PD), and Energy Transfer LP 7.60% CUM PFD E (NYSE:ET.PE). Being bullish on ET extended to my being bullish on ET's preferred shares. I realize that the preferred are senior to the common shares. While I appreciate that bit of protection, my long-term thesis is bullish for all of ET. At the end of August, right after the Jackson Hole meeting, I was doing my analysis and acquiring my initial positions. The pertinent information that I was using is shown below.

Issue

Price (8/26/23)

Annual Dividend

Yield

Reset or Call Date

Reset Rate (plus LIBOR)

$25 par value rate

Shares

Issued

Repurchase

Price

ET.PC

$22.50

$1.8438

8.2%

5/15/23

4.53%

7.375%

18M

$25, $25.50

ET.PD

$22.60

$1.9063

8.4%

8/15/23

4.74%

7.625%

16M

$25, $25.50

ET.PE

$23.84

$1.9000

8.0%

5/15/24

5.16%

7.600%

28M

$25, $25.5

Since the shares were issued, LIBOR has been obsoleted. It's my understanding that Energy Transfer has not yet definitively stated what the 90-day LIBOR replacement measure will be. A reasonable assumption for me was that the LIBOR replacement would match what Congress passed into law in March 2022. That is the 90-day SOFR (secured overnight financing rate) plus a constant of .262%. This is legislated to start June 30, 2023, for securities that didn't make prior provisions for LIBOR ending.

Given that the issues all reset, or can be called, in the next 24 months, I wanted to understand what the implications would be if my shares weren't called but the rates reset. The big elephant in the room is what you think the SOFR will be at that time. I decided to go with EconForecasting's outlook. They feel that SOFR next May will be 3.81%, 3.73% in August, and 3.09% in August 2024. I didn't have a 90-day SOFR rate, so I just went with the SOFR rate they are projecting for each period. I'm assuming that a 90-day rate will smooth out the data. It'll be slow to rise, but also slow to fall. This is inexact, but for estimation purposes it's the best I could do.

The estimates for rate of return at $25 par value, return at par value, projected yield, and projected return are estimated below from now through 2024. After 2024, all the instruments should have been reset or potentially recalled.

Rate at $25 par value

11/15/22

2/15/23

5/15/23

8/15/23

11/15/23

2/15/24

5/15/24

8/15/24

11/15/24

SOFR

3.810%

3.730%

3.500%

3.320%

3.170%

3.060%

3.050%

ET.PC

7.375%

7.375%

8.602%

8.522%

8.292%

8.112%

7.962%

7.852%

7.842%

ET.PD

7.625%

7.625%

7.625%

8.732%

8.502%

8.322%

8.172%

8.062%

8.052%

ET.PE

7.600%

7.600%

7.600%

7.600%

7.600%

7.600%

8.592%

8.482%

8.472%

Payment at $25 par value

11/15/22

2/15/23

5/15/23

8/15/23

11/15/23

2/15/24

5/15/24

8/15/24

11/15/24

ET.PC

0.46094

0.46094

0.53763

0.53263

0.51825

0.50700

0.49763

0.49075

0.49013

ET.PD

0.47656

0.47656

0.47656

0.54575

0.53138

0.52013

0.51075

0.50388

0.50325

ET.PE

0.47500

0.47500

0.47500

0.47500

0.47500

0.47500

0.53700

0.53013

0.52950

Using these estimates, I then forecast what the total return would be between now and the end of 2024, when all the securities shares will have been reset.

Price 8/26/22

2022 payment

2022 Yield

2023 payment

2023 Yield

2024 payment

2024 Yield

Total

Yield

ET.PC

$22.50

$1.8438

8.194%

$2.0494

9.109%

$1.9855

8.824%

$5.8787

8.709%

ET.PD

$22.60

$1.9063

8.435%

$2.0303

8.983%

$2.0380

9.018%

$5.9745

8.812%

ET.PE

$23.84

$1.9000

7.970%

$1.9000

7.970%

$2.0716

8.690%

$5.8716

8.210%

Another wildcard in the assessment is the chance that Energy Transfer will call back the securities after the reset/call dates. If they do repurchase the shares, the set price is $25.00. It also might be more likely that either, or both, ET.PC and ET.PD all called due to their lower outstanding shares. At 18 million and 16 million, respectively, it would cost Energy Transfer considerably less to recall those shares rather than the 28 million shares of ET.PE. In the case of re-rating event by the ratings agencies, the repurchase price will be $25.50.

What does the market say?

The interesting thing in this entire exercise was how the market values these instruments vs. what I see as their value. It doesn't appear as if the market is taking into account the repricing of the shares or the potential for SOFR to rise significantly. These instruments should act somewhat as inflation protection, moving upward as inflation moves upward. If you look at current pricing, the ET.PE shares seem to be the most valued. This makes sense if you assume that interest rates will stay stable. It doesn't make sense to me if you assume that interest rates will rise, and the preferred securities will reset with higher rates than they have now.

The way I see it, the most desirable instrument to hold is ET.PD with an 8.8% yield over the next years, followed by ET.PC. Beyond 2024, ET.PD still looks to me to be more desirable. ET.PE does have a better return (8.884%) than ET.PC (8.713%) at the end of 2024, but it's only 17bps. ET.PE will always have the advantage over ET.PC in the longer term given that it resets to +5.15% vs. ET.PC's +4.53%. Add in a high enough SOFR and it does become a bit of noise. At a lower SOFR, it's obviously more significant.

When you factor in the chance that the shares might be called back, I prefer ET.PC to ET.PE. Given the much lower price of ET.PC, and its higher return though 2024, I hope that they do call it back. If that happens, my total return will be better with ET.PC rather than ET.PE. It's also hoped that during the time period of May 2023 through November 2024, when ET.PC is yielding higher than ET.PE, that the market would reprice ET.PC higher.

Outcome

So, what did I do? I ended up purchasing all of the above. In my IRA and Roth IRA accounts, ET.PC is 50% of my holdings, ET.PD is 24%, and ET.PE is 26%. I also continue to hold ET in my brokerage account. At this time this was written, it doesn't appear as if I've made the best choices - the shares are getting hammered and ET.PC is down the most. I take some comfort in the fact that the shares will reprice, and if interest rates continue upward, the reprice should be appreciably higher. It does offer some inflation protection if rates continue to climb.

It would also be helpful to hear definitively from Energy Transfer exactly what 90-day LIBOR replacement that they will be using. We could all make better informed investment decisions with that information.

This article was written by

Looking For Income profile picture
121 Followers
Actively managing a midsized portfolio over the last 20 years with high single-digit return. Three down years in the last eighteen years.

Disclosure: I/we have a beneficial long position in the shares of ET, ET.PC, ET.PD, ET.PE either through stock ownership, options, or other derivatives. 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.

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