Energy Transfer: Undervalued Blue-Chip Midstream
Energy Transfer (ET) is a blue-chip midstream master limited partnership (MLP) with a very large, fully-integrated, and well-diversified portfolio of assets. The midstream sector involves the transportation, storage, and wholesale marketing of crude or refined petroleum products. Energy Transfer spans the midstream value chain and generates almost entirely fee-based cash flows, as roughly 90% of its cash flow comes from commodity-resistant contracts. The energy company operates five businesses (Crude Oil, NGL & Refined Products, Interstate Transport & Storage, Midstream, and Intrastate Transport & Storage), with no single business occupying an outsized portion of their cash flows. Furthermore, ET is one of the only midstream businesses that services all 15 major U.S. oil and gas producing regions in the U.S., giving it significant geographic diversification and scale competitive advantages. (See ET stock analysis on TipRanks) Underperformance Factors Despite its recent strength, ET has significantly underperformed peers in recent years, due to the several factors. For one, the company has encountered numerous regulatory headwinds on its projects (such as the Dakota Access Pipeline), leading to costly delays and legal fees which in turn have weighed on its valuation. Additionally, it has taken on heavy leverage to finance its aggressive growth projects and acquisitions. That leverage forced the company to slash its distribution in half in 2020 in order to apply more cash flow towards repaying debt. In fact, leverage reached a point where ratings agencies threatened to remove their investment grade credit rating if Energy Transfer did not show demonstrable deleveraging progress soon. The Good News for ET That said, ET’s Q1 fiscal year results seemed to indicate that the MLP is turning a corner. That company profited billions of dollars from winter storm Uri, and promptly applied those profits to paying down debt. In addition, as the economy continues to re-open from COVID-19 restrictions, energy demand is accelerating, leading to greater volumes through ET’s midstream network and firmer demand for its existing contracts. As a result, ET’s negative outlook on its credit rating has been removed and the balance sheet appears to be on a clear path toward securing its investment grade credit rating. Another recent piece of excellent news for the company was the D.C. District Court’s decision to allow the Dakota Access Pipeline to remain open while the U.S. Army Corps of Engineers conducts their Environmental Impact Study. The study is expected to be completed in the Spring of 2022. Once the balance sheet leverage reaches management’s target of under 4.5x, ET has signaled that it plans to pursue either increased distributions or initiating equity buybacks, depending on market conditions at the time. In other promising news, ET’s Founder and Chairman Kelcy Warren recently stated that he wants the MLP to acquire a chemicals and plastics business in order to further diversify the company and position it for long-term competitiveness and viability in a fast-evolving energy industry. Valuation Metrics Given its quality and well-diversified asset portfolio, strong recent results, encouraging Dakota Access Pipeline developments, improved outlook for deleveraging, shareholder capital returns, and potential growth acquisitions, ET looks very undervalued right now. Its EV/EBITDA is the lowest among all investment grade midstream businesses, and its well-diversified, fully integrated asset portfolio with significant exposure to natural gas and export growth opportunities makes it one of the higher quality options in the space. Furthermore, its Distributable Cash Flow yield is expected to cover their distribution by 4x-5x moving forward, making its hefty 6% distribution yield perhaps the safest high yield in the market today. Meanwhile, the billions of dollars in retained cash flow will be used to create additional investor equity by paying down debt at an aggressive clip, which in turn will generate additional distributable cash flow via reduced interest expense. Eventually, we can expect it to be used for buybacks and/or distribution growth. Wall Street’s Take From Wall Street analysts, ET earns a Strong Buy analyst consensus based on 8 Buy ratings in the past 3 months. Additionally, the average analyst price target of $13.38 puts the upside potential at 33%. Summary and Conclusions ET has had a turbulent past, as the company has suffered from disappointing returns on many of its growth investments and acquisitions. As a result, its leverage became elevated and management had to slash its distribution. Despite those drawbacks, it still has a lot going for it: one of the best overall asset portfolios in the midstream sector, an investment grade balance sheet that is being rapidly deleveraged, a hefty distribution yield covered several times over by distributable cash flow, one of the cheapest valuations in the midstream sector, and promising growth potential moving forward. Last but not least, every single analyst who has covered it in the past 3 months gives it a Buy rating and the average price target leaves nearly 30% upside from the current unit price. Based on these indicators, ET could be a good buy right now. Disclosure: On the date of publication, Samuel Smith had a long position in Energy Transfer. Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.