Energy Transfer Vs Western Midstream: Which Is A Better Buy?

Energy Transfer (NYSE:ET) and Western Midstream Partners (NYSE:WES) are among the cheapest investment grade midstream businesses in the market today.

ET’s EV/EBITDA ratio is one of the lowest among investment grade midstream businesses at 7.73x along with a miniscule price to distributable cash flow ratio of 4.21x. Meanwhile, WES boasts an even cheaper 7.43x EV/EBITDA ratio along with a price to distributable cash flow ratio of just 5.47x. By way of comparison, peers like Enterprise Products Partners (EPD) has an EV/EBITDA ratio of 9.25x, MPLX (MPLX) has an EV/EBITDA of 8.95x, and Kinder Morgan’s (KMI) is 9.58x.

While both are considerably cheaper than peers, ET is significantly cheaper on a P/DCF basis whereas WES wins the EV/EBITDA competition. In this article we will compare ET and WES side-by-side across the various aspects of their businesses in order to determine which one is the better buy right now.

Energy Transfer Vs. Western Midstream – Asset Portfolios

WES gathers, processes, and transports natural gas and natural gas liquids and operates assets located in Texas, New Mexico, the Rocky Mountains, and North-central Pennsylvania.

The majority of the company’s cash flows come from fee-based contracts. Since the contracts are fee-based, the company still makes money even if lower volumes go through, and they have minimum-volume commitments in place to make sure that even if commodity prices take a dive, there will still be a certain level of throughput (volume) that WES will make money from:

We believe a substantial majority of our cash flows are protected from direct exposure to commodity-price volatility, as 93% of our wellhead natural-gas volume (excluding equity investments) and 100% of our crude-oil and produced-water throughput (excluding equity investments) were serviced under fee-based contracts for the year ended December 31, 2021. In addition, we mitigate volumetric risk through minimum-volume commitments and cost-of-service contract structures. For the year ended December 31, 2021, 81% of our natural-gas throughput, 96% of our crude-oil and NGLs throughput, and 100% of our produced-water throughput were supported by either minimum-volume commitments with associated deficiency payments or cost-of-service commitments.

– WES 2021 10-K

And here, the company defines “fee-based”:

Fee-based. Under fee-based arrangements, the service provider typically receives a fee for each unit of (i) natural gas, NGLs, or crude oil that is gathered, treated, processed, and/or transported, or (ii) produced water gathered and disposed of, at its facilities. As a result, the per-unit price received by the service provider does not vary with commodity-price changes, thereby minimizing the service provider’s direct commodity-price risk exposure.

– WES 2021 10-K

Its best assets are located in the Delaware Basin where it is the only low-emission oil gatherer, only three-stream midstream provider, 2nd in water gathering and disposal, and third in gas processing capacity.

Energy Transfer, meanwhile, boasts one of the most diversified asset portfolios in the midstream space. ~90% of its expected 2022 adjusted EBITDA is set to come from fee-based contracts, with the remainder subject to commodity volatility. As a result, it should have a very stable cash flow profile. On top of that its Q1 adjusted EBITDA came from 5 different business segments, the smallest of which contributed 10% and the largest of which contributed 27%. Only 18% came from crude oil and the vast majority came from natural gas related businesses, making its profile weighted towards the much brighter future for natural gas rather than for crude oil. Insiders own 13% of the business, giving them plenty of skin in the game. Last, but not least, ET’s market share of worldwide NGL exports stands at a whopping 20%, making it a major player in the space.

Energy Transfer Vs. Western Midstream – Q1 Results

ET’s Q1 FY 2022 results were pretty strong, the highlights being:

• Full year adjusted EBITDA guidance was raised by 3.3%.
• Management announced that subsequent to quarter end, ET reached an all-time monthly throughput record for fractioned volumes in April, averaging more than 900K bbl/day.
• Management also announced the completion of the final phase of the Mariner East project during Q1, which should serve as a boost to cash flows.
• The company announced the sale of its interest in Energy Transfer Canada in a move that is expected to reduce consolidated debt by approximately $450 million. Management also said that “we’re getting closer to the 4.5” leverage target ratio, a very positive sign that implies that it will soon be fully freed up to restore the distribution to its pre-cut $1.22 annualized level.
• Meanwhile, management announced a $0.20 per unit common distribution in Q1, a more than 30% year-over-year increase.

We are very pleased with the progress that ET is making on our investment thesis. Management continues to aggressively deleverage the balance sheet while also increasing the distribution level, with more hikes signaled in the near future. We remain happily long ET – especially after our recent exclusive interview with them – and would have no issues with buying more on dips into our Strong Buy range

Meanwhile, WES also reported solid Q1 FY 2022 results. Highlights from the period included:

• The midpoint of guidance for adjusted EBITDA increased by ~10% and by ~4% for free cash flow.
• The company’s balance sheet remains in strong shape with well over $2.2 billion in total liquidity, which more than covers total debt maturities through 2025.
• Management continued to prudently pay down debt, retiring $502 million of senior notes on April 1st.
• Management also signaled that they could potentially pay out a special distribution next year from this year’s increased $2.00 projected total payout, stating on the earnings call:

these updated guidance figures very much put as a potential opportunity and enhanced distribution to be paid in 2023. We think it’s a really exciting development in a lot of the successes that we’ve had this quarter and expect for the remainder of the year and very much was core to our thought about the financial policy for our unitholders to be able to get rewarded for the successes that we’re able to achieve during each annual year.

Overall, our investment thesis on the business is playing out nicely and we look forward to continued hefty distributions and capital gains in the months and quarters to come.

ET Vs. WES: Growth Outlook

On top of offering very attractive current distribution yields (ET’s is 7.89% and WES’s is 8.37%), both businesses are forecast by analysts to experience meaningful growth in the coming years.

ET is expected to grow its distribution per unit at a 10.8% CAGR (to a 12.52% yield on current cost) through 2026 while its distributable cash flow per unit is expected to grow at a 1.8% CAGR (to a 25.54% DCF yield on current cost) over that same time span as growth investment and inflation-related contract increases will more than offset legacy business and contract declines.

WES is expected to grow its distribution per unit at a 7.4% CAGR (11.55% yield on current cost) through 2026 while its distributable cash flow per unit is expected to grow at a 5.2% CAGR (to a 23.60% DCF yield on current cost) over that same time span thanks to strong upside potential in its assets, substantial unit buyback program, and growth investments.

Investor Takeaway

Overall, we like both businesses. They both look quite undervalued relative to peers and on an objective basis. Furthermore, their asset portfolios are solid and their balance sheets have been freshly deleveraged, are investment grade, and are poised to continue getting better moving forward. Performance momentum is strong with tailwinds in their industry. Last, but not least, both businesses are expected to combine attractive current yields with strong distribution per unit growth moving forward.

While it is difficult to say which is more attractively priced (WES offers a slightly higher current distribution yield and slightly cheaper EV/EBITDA valuation whereas ET offers slightly better 2026 projected distribution and DCF yields on current cost and trades at a much cheaper P/DCF multiple at present), we give the overall edge to ET given that its portfolio is larger and more diversified, representing lower risk in our view. We also see it as being able to achieve continued strong growth in its worldwide NGL export business, which could cause it to outperform analyst consensus estimates for DCF per unit growth between now and 2026.

Still, we really like WES as well and are long both MLPs as a result.