After a torturous path, unitholders of Energy Transfer (NYSE:ET) finally see the light at the end of the tunnel. The declining unit price was an issue pre-pandemic, and units were stuck in the single-digit limbo for entirely too long. Investors that never sold watched as units dropped under $5 per share in the Covid-Crash, only to touch double digits briefly in May of 2021 and return to single digits in July. Since the beginning of February 2022, units have held the line for the most part, and we’re closing in on pre-pandemic levels.
ET reported a solid Q1, reporting $3.34 billion of Adjusted EBITDA and $2.08 billion in Distributable Cash Flow (DCF). By acquiring Enable Midstream and SemGroup, ET has created the largest energy infrastructure company in America, with nearly 120,000 miles of pipeline and exporting capabilities on both the East and Gulf Coasts. It absolutely breaks my heart that the war in Ukraine was the event that magnified the relevancy of fossil fuels. In 2022, ET entered into 4 long-term LNG purchase agreements accounting for 4.7 million tonnes of LNG per annum over 20 years, plus another 0.4 million tonnes per annum over 18 years. The demand for energy continues to increase, and the EIA expects the global demand for energy to increase by 50% by 2050. ET just raised its 2022 guidance and has a long runway to benefit from the increase in global energy demand to be met by American energy. Unitholders have a lot to be thankful for as we just got our 2nd consecutive distribution increase while management indicated that the goal is to restore ET to its previous $1.22 annual distribution. I think units will continue to move higher in 2022, as ET is undervalued compared to its peers and the energy trade continues to live on.
Energy Transfer is still undervalued and even though the single digits seem to be gone, there is still time to jump on the train
It’s astonishing that the market continues to discount units of ET compared to its peers. I went through the previous 4 quarters for ET, Enterprise Products Partners (EPD), Kinder Morgan (KMI), and MPLX LP (MPLX) and tabulated each company’s revenue, Adjusted EBITDA, DCF, and Total Debt. I will compare ET to its peers across the following metrics to illustrate how severely units of ET are being discounted:
- Adjusted EBITDA to Market Cap Ratio
- DCF to Market Cap Ratio
- Debt to Market Cap Ratio
- Price to Sales
Over the TTM, ET has generated $11.35 billion in Adjusted EBITDA, $7.9 billion in DCF, and has amassed $49.64 billion in Total Debt. The investment community has often cited and looked poorly upon ET’s debt level due to the metric on an absolute value level. While debt is a liability, in many cases, tapping the debt market is the cost of doing business, unless you are one of the rare companies that doesn’t have long-term debt on its balance sheet, such as Meta Platforms (FB).
To frame the metrics, I want to highlight the size of each company and the amount of revenue their business generated over the TTM:
ET currently trades at a 3.16x Adjusted EBITDA to Market Cap ratio. This is significantly lower than MPLX, which trades at 5.88x, KMI trading at 6.16x, and EPD, which trades at 9.56x. ET has a similar market cap to MPLX, generates around double the amount of Adjusted EBITDA, and trades at an 86.24% discounted valuation to MPLX’s Adjusted EBITDA to Market Cap ratio. EPD has an Adjusted EBITDA to Market Cap ratio that’s 3x ET’s while ET has generated $5.2 billion more in Adjusted EBITDA.
Distributable Cash Flow is one of the most important metrics when looking at energy infrastructure companies, as this is the amount of cash available for redistribution to its investors. Of the peer group, ET has generated the largest amount of DCF with $7.9 billion, followed by EPD at $6.71 billion, then $4.86 billion from MPLX, and $4.59 billion from KMI. EPD trades at a 4.54x DCF to Market Cap Ratio while its peers trade at 6.78x for MPLX, 8.74x for EPD, and 9.54x for KMI. While ET generates the largest amount of revenue, Adjusted EBITDA, and DCF, it still has the lowest valuation in this category as well, indicating the market is undervaluing its units.
Debt has often been a sticking point for the market with ET, and for a good reason, ET has more than double the amount of debt that MPLX has and significantly more than EPD and KMI. Just because a company has a large amount of debt doesn’t mean it’s unable to fulfill its debt service obligations. AT&T (T) is a perfect example; this is a company that had a mountain of debt that was the cause of contention for many, but due to T’s large levels of FCF, the debt service and repayment obligations weren’t in jeopardy. Due to the size of ET’s debt load, one would speculate that its Debt to Adjusted EBITDA ratio would be higher than its peers. The results show that ET is valued in the same range as they trade at a 4.54x Debt to Adjusted EBITDA ratio. EPD has the largest ratio at 4.87x, and KMI follows at 4.53x, while MPLX is at the bottom of the range, trading at 3.67x.
I normally don’t care for the Price to Sales metric as much as other financial metrics, but in ET’s case it’s interesting. The market has placed a 0.51 P/S ratio on ET compared to its peers. EPD trades at a 1.31x P/S, KMI at 2.79x P/S, and MPLX at 3.31x P/S. I added this metric to illustrate how the market isn’t even valuing ET at 1x sales, yet large multiples are placed on KMI and MPLX.
The financial metrics indicate that ET is certainly trading within a respectable range on its Debt to Adjusted EBITDA ratio, but it’s undervalued on an Adjusted EBITDA to Market Cap, DCF to Market Cap, and a Price to Sales metric. Due to its level of debt, maybe ET shouldn’t trade at 1x sales, but it’s had to justify its current market cap due to its level of debt. Based on these metrics, ET looks undervalued compared to its peers as it trades at the most attractive valuation in 3 of the 4 categories while trading at the 2nd lowest valuation for the Debt to Adjusted EBITDA ratio.
Energy Transfer has a major advantage over its peers with exporting, and due to the global events, this segment will become more important than I originally thought
I have often said that exporting will become a major source of revenue for energy infrastructure companies throughout the 2020s. Unfortunately, it took a war in Ukraine for the leaders of the free world to acknowledge the current dependence on fossil fuels, in particular natural gas. In 2021, Germany imported 142 billion cubic meters of gas, and 32% flowed through Russian pipelines. Overall, Russia supplies roughly 40% of Europe’s natural gas imports. The atrocities taking place in Ukraine are heartbreaking and forced the free world to isolate Russia. Germany has halted Russia’s $11 billion Nord Stream 2 pipeline project announcing that Berlin would stop the certification. On Monday, 3/1, the United Kingdom ordered that Russian-associated vessels be blocked from its ports, and on 3/2, the European Parliament called for the entire EU to close its ports to Russian ships or ships going to or from Russia. Germany has been at the forefront of the renewable energy transition, and on Tuesday, 3/1, Chancellor Scholz addressed the German Parliament and said that Germany is looking to expedite the construction of two liquefied natural gas (LNG) terminals as it wants to cut ties with Russian gas, following the assault on Ukraine.
The White House released a statement announcing the creation of a task force to reduce Europe’s dependence on Russian fossil fuels. The statement indicated that EU member states will ensure demand for approximately 50bcm/y of additional US LNG until 2030. The U.S. will be working with international partners to ensure additional LNG volumes for the EU market of at least 15bcm in 2022. There are going to be many winners in this space, but ET is currently positioned to benefit from transporting and processing the necessary fuels stateside while also generating additional revenue from its exporting facilities to help meet the global demand for energy. In the 3/3/22 Annual Energy Outlook 2022 report, the EIA projected that in 2050 the USA would be dominated by fossil fuels. Coal is expected to decline while oil climbs back to its previous highs of the early 2000s and natural gas continues to increase. Both see increased demand over the next 3 decades. On 10/6/21, the EIA released its international energy outlook and indicated that its baseline scenario calls for the global energy demand to increase by 50%, growing from 600 quadrillion BTUs in 2020 to 900 quadrillion BTUs in 2050. While renewables have stolen the spotlight and will aggressively grow in the coming decades, oil and gas will remain top energy sources within the energy mix.
On the recent conference call, we learned that ET has entered into four long-term LNG sales and purchase agreements. ET is expected to supply a total of 4.7 million tonnes of LNG per annum over 20 years, plus another 0.4 million tonnes per annum over 18 years, with first deliveries expected to commence as early as 2026. As I indicated, there should be many winners in this space. I went through the data from FERC and identified every investible company for LNG export facilities. In my table below, I have existing facilities, approved facilities that are under construction, and approved facilities where construction hasn’t started. I identified the parent company of each facility, listed the investible ticker symbol or if the company is private, and listed some other critical information.
ET will have the sixth largest exporting capacity out of the Lake Charles facility from the publicly traded companies that have approved LNG export facilities. There is little chance that the Lake Charles Export Facility won’t reach an FID and be constructed. This facility has been approved and is fully permitted. The beautiful aspect is that this facility already exists as an LNG import facility. ET will be converting it to an LNG export facility.
In addition to future LNG exports, ET has three current export facilities generating currently operational. The Houston Terminal has 500,000 bbls/d of crude export capacity, Nederland has 600,000 of crude and 700,000 bbls/d of LPG, ethane, and gasoline export capacity, while the Marcus Hook facility can export 400,000 bbls/d of LPG and ethane. As the global demand for energy grows, ET’s exporting facilities will become more critical to meeting the global demand for energy.
An increased global demand for energy means more sources of energy need to be produced and transported
By now, it’s clear that 100% renewable isn’t happening anytime soon. I am not saying this won’t occur, but the timetable certainly doesn’t point to 2040. One of the things to look at is where the major basins within the U.S are then where the midstream operator’s assets lay.
ET, to my knowledge, has the largest pipeline infrastructure within the U.S, and it connects most of the major basins to critical refining, terminaling, and exporting infrastructure. ET continues to expand its capabilities, and during Q1, ET completed the final phase of the Mariner East project and the expansion of the Cushing South crude oil pipeline. With the Mariner East project completed, ET’s total NGL capacity increased to more than 365,000 barrels per day, including ethane. The Cushing South pipeline provides transportation service from the Cushing to Nederland Terminal and the Permian Bridge, which connects to processing assets in the Delaware and Midland Basins.
In addition to the completed projects, ET started construction on the new 200 MMcf per day Grey Wolf high-recovery cryogenic processing plant due to increased customer demand for growing natural gas volumes in the Permian Basin. ET started construction on the Gulf Run Pipeline, which is a 42-inch pipeline with 1.65 Bcf per day of capacity. This should be completed by the end of Q4 and provide natural gas transportation between the Haynesville Shale Basin and the U.S. Gulf Coast. The Ted Collins Link was also placed into service connecting the Gulf Coast pipeline network and the Houston Ship Channel.
Energy Transfer is growing its distribution quicker than I had expected
The distribution reduction took many unitholders, including myself, by surprise, and it was a sobering moment. Many didn’t believe that ET would go ahead with their fiscal responsibility promises and that this was a ploy by Kelcy Warren and his supporters. ET is proving some investors wrong, and while some of its expansion decisions weren’t agreed with, ET took the opportunity to strengthen its business and deal a blow to its peers. The Enable acquisition was critical to adding major assets in Middle America, and for unitholders, it’s better that ET added these assets than a company such as KMI.
The quarterly distribution fell from $0.31 to $0.15 at the end of 2020 when ET announced its financial plan. Many would have thought that acquisitions were off the table and the focus would be on its debt load, but over the past year, ET was able to acquire Enable while improving its balance sheet and increasing the level of revenue, DCF, and Adjusted EBITDA their combined operations generate. After 5 consecutive quarters of a reduced quarterly distribution, ET has provided 2 consecutive increases, first to $0.18 and next to a quarterly distribution of $0.20. Over six months, ET has provided a 33.33% increase to its quarterly distribution. Management reassured investors that future increases to the distribution level would continue to be evaluated quarterly with the ultimate goal of returning distributions to the previous level. At this rate, we could see the previous level reached by 2024 if future quarters mimic this one.
In a rising rate environment where free money is non-existent, and technology multiples are compressing, boring energy companies are looking mighty attractive. We are seeing extreme commodity prices combined with a growing demand for both fossil fuels and renewables. ET is one of the largest energy infrastructure companies in North America and is trading at a discount to its peers. The increasing demand and the energy crisis in Europe put greater importance on ET’s assets than pre-pandemic. Due to regulations, capital requirements, and government red tape due to permitting and environmental studies, the entry barriers are immense, and new competition is almost non-existent. Today it would be almost impossible for a new entity to rebuild ET’s infrastructure, not just for these reasons but also due to land requirements and proximity to basins and terminal facilities. ET should continue to strengthen its Adjusted EBITDA and DCF over the years as more fuels flow through its system. More fuels will move through ET’s system as production increases, adding to their top and bottom lines. While ET has bounced significantly off its lows, I think $15 could be a realistic number for the end of 2022, and as ET decreases its debt load, we could see a run on $20 per unit.
Read More: Energy Transfer: Distribution Increases, Unit Price Appreciating