onurdongel
For years, the rap on Energy Transfer (NYSE:ET) was overly aggressive management decisions that put the company, its finances, and its investors into the line of fire. A confluence of events, some outside management’s control and some just unforced errors created an investment offering opportunity but unendingly hindered by unstable performance. Yield-chasers rushed in, compounding matters.
Well, friends, several long-term trends appear to be changing.
In this article, we will examine specifics:
-
balance sheet and debt leverage trends
-
EBITDA growth
-
remarkable year-over-year volume growth
In addition, we will touch upon several other topics:
-
the cash distribution
-
preferred stock
-
LNG and Petrochemical business opportunities
Note to Readers: financial data inputs for the foregoing found on 10-K documents and various Energy Transfer earnings releases. Calculations by the author.
The Balance Sheet and Debt Leverage
Good companies have sound balance sheets. Energy Transfer hasn’t been one of the exceptions. Indeed, the stock has been punished for an over-leveraged balance sheet and relatively poor capital returns.
A balance sheet may be evaluated in a number of ways. For today’s case, I offer three basic metrics I believe are most apropos to Energy Transfer and its industry (Oil & Gas Midstream / Pipelines).
-
debt leverage ratio
-
equity build
-
Return-on-Invested-Capital
Debt Leverage Ratio
As discussed in previous articles, a key rating agency debt metric is the debt leverage ratio. Broadly, this is adjusted EBITDA divided by total debt and lease liabilities. The numerator and denominator are adjusted for affiliate activity, including non-recourse debt. The three major rating agencies do not utilize the same methodology; however, the calculations are similar.
All the agencies set expectations management reduce debt leverage within a 4.0x to 4.5x range.
For several years, I have been offering readers what I understand is the S&P 500 “cash EBITDA” methodology.
Taking a step back, here’s the debt leverage scorecard for the past several years.
Energy Transfer Partners – Debt Leverage Ratio (Year-end)
|
2020 |
2021 |
2022E |
|
5.5x |
4.9x |
4.0x |
Notes:
The year-end 2021 ratio was calculated excluding the one-time, $2.5 billion windfall associated with Winter Storm Uri. Otherwise, the ratio would be materially lower. The attempt here is to normalize the ratio to corresponding core business operations.
The 2022 ratio is an estimate. My estimate is based upon management guidance and recent updates. I have relative confidence in these figures. First, Moody’s rating agency upgraded Energy Transfer’s current investment-grade rating from “stable” to “positive.” Second, Moody’s indicated their analysts expect ET to finish 2022 with a 4.2x leverage ratio. My understanding is Moody’s calculation is a bit more conservative than S&P 500.
The trend is clearly downward and aligned with reaching the 4.0x to 4.5x target. It appears management will reach the goal by YE 2022.
Equity Build
Another straightforward approach to evaluating management effectiveness and the balance sheet is to check whether total stockholder equity is increasing. If one supposes management is tasked with creating unitholder value, then equity (total assets minus total liabilities) should trend upwards.
Here is a chart outlining five years’ worth of total stockholder equity:
Energy Transfer Partners – Total Stockholder Equity (Year-end in $B)
|
2018 |
2019 |
2020 |
2021 |
2022E |
|
30.9 |
33.8 |
31.4 |
39.3 |
41.1 |
Notes:
The 2022 equity figure is an estimate. My estimate is based upon management guidance and updates. In December, management announced it placed a $2.5 billion debt offering. While some of the proceeds are expected to go towards debt repayment, I cannot be sure how much will be utilized for debt paydown versus general corporate purposes.
Nonetheless, the general five-year trend is upward.
Return-on-Invested-Capital
For several years, I have suggested part of the reason Energy Transfer stock doesn’t receive the valuation multiples many of its peers enjoy is due to lagging RoIC. While the utility and calculation details of this metric are open for healthy debate, many good investors use it.
I believe comparing RoIC with WACC (Weighted Average Cost of Capital) helps determine management effectiveness. If RoIC is greater than WACC, value is being created. Conversely, if RoIC is lesser than WACC, it may signify value destruction.
Here’s a table outlining RoIC trends:
Energy Transfer Partners – Return-on-Invested-Capital (Year-end)
|
2018 |
2019 |
2020 |
2021 |
2022E |
|
6.90% |
7.00% |
6.50% |
8.70% |
9.20% |
Notes:
I calculated RoIC using DCF (Distributable Cash Flow) versus the more traditional EBIT. Substituting DCF in the numerator of the formula generally produces lower returns than EBIT. However, given the nature of Energy Transfer’s business, I believe DCF provides investors a more accurate indication of overall core business performance.
The 2022 figure is an estimate. My estimate is based upon management guidance and updates.
For reference, Energy Transfer’s current WACC is estimated to be 8.25 percent. As such and when compared to RoIC, it suggests management is creating stockholder value. This is a relatively recent phenomenon.
None withstanding, the general five-year RoIC trend is upward.
EBITDA Growth
In addition to DCF, most midstream pipeline companies utilize and track adjusted EBITDA. Energy Transfer is aligned with this view. While I am not a big fan of EBITDA, in a previous article, I pulled the metric apart and became reasonably comfortable with it. Management provides quarterly EBITDA guidance updates.
Here’s a five-year chart highlighting adjusted EBITDA:
Energy Transfer Partners – Return-on-Invested-Capital (Year-end $B)
|
2018 |
2019 |
2020 |
2021 |
2022 E |
|
9.5 |
11.1 |
10.5 |
13 |
13 |
Notes:
Year-end 2021 adjusted EBITDA was $13.0 billion. However, this included a one-time, $2.5 billion windfall due to Winter Storm Uri. Excluding this event, 2021 adjusted EBITDA was $10.5 billion.
Year-end 2022 adjusted EBITDA is an estimate. In the 3Q 2022 earnings report, management included updated EBITDA guidance: $12.8 billion to $13.0 billion. Based upon the current track record, I believe actual full-year results will lean towards the upper end of the guidance range.
The five-year EBITDA trend is upward.
Volumes
Through 3Q 2022, Energy Transfer’s core business (hydrocarbon transportation) enjoyed remarkable year-over-year growth. I took the time to compile YTD transportation figures for 2022 versus 2021. The summary is found on the table following:
Energy Transfer Partners – YoY Transportation Volume Improvement
|
Natural Gas (Bbtu/d) |
NGLs (Bbtu/d) |
Crude (‘MBD’) |
|
35% |
40% |
12% |
Notes:
Volumes include transportation and gathering.
As the price of crude oil has skyrocketed, natural gas wants to move from the domestic production fields to market. Demand for hydrocarbons remains high. Energy Transfer assets reside in all the major U.S. production basins.
Other Topics of Investor Interest
Cash Distributions
Over the past several quarters, Energy Transfer management has raised the common unit cash distribution by about 15 percent per quarter. Over time, most investors “cracked the code.” The arithmetic indicates one more comparable increase will restore the old $1.22 per unit distribution.
In October 2020, ET cut the distribution in half. It appears it’s taken about two years to reinstate it. Using today’s closing price and presuming $1.22 go-forward cash distribution, the common units will yield 10.2 percent.
Preferred Stock
Several years ago, Energy Transfer management worked with the rating agencies and resolved to issue preferred stock. The agencies agreed to consider the preferred shares 50/50 debt / equity. The move helped repair the balance sheet without having to issue debt and risk triggering a rating downgrade.
Several flavors (A, C and D preferred shares) begin to float in 2023 (see page F-37 in the linked 10-K). Presuming SOFR will be the benchmark and current rates remain approximately the same, these shares are likely to find the dividend payment will increase.
Given strong cash flow and good debt leverage metrics, it would seem unsurprising if the company called issues of preferred stock.
LNG and Petrochemical Business Forays
There’s been ongoing hubbub about Energy Transfer management chafing at the bit to do a petrochemical or LNG deal. While such business development activity may come to fruition, I believe there’s been excess handwringing over it.
My expectation is any potential deal will be cash-accretive and likely include heavy fee-based contracts and / or joint interest business arrangements whereby Energy Transfer lays off risk to other partners.
ET is likely to sell equity interest in such ventures to other entities that are willing and able to handle the financial and commodity risks associated, leaving Energy Transfer with a conventional fee-for-service model, facility operations management, and long-term leasing / contract arrangements.
My preference would be for Energy Transfer management to stop talking about these potential deals. When it’s ripe, announce it. When it’s not, don’t poke it.
Bottom Line
Energy Transfer management appears to be settling into a forward path highlighting cash returns, a far better balance sheet, lower growth capex, and a lower overall risk profile. Founder Kelcy Warren continues to have significant influence on the company but has turned over running the business to others.
Growth isn’t out. It simply appears to be focused upon limited business development, better economics, a lower profile, and a willingness to offload financial and business risk to partners via joint venture arrangements.
Presuming the cash distribution is raised another 15 percent upon the next quarterly declaration and buttressed by far more consistent operational and cash performance, I believe common units remain undervalued.
Please do you own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2022 investments.
Be the first to comment