Units of Energy Transfer (NYSE:ET) are available at a 6.9% distribution yield and a very low valuation. The energy firm will remain critical in helping its partners meet their energy needs for at least the next two decades. Investors can look forward to strong distribution growth and units have considerable revaluation potential!
The long-term case for Energy Transfer
Possibly one of the biggest misconceptions about the fossil fuel industry, and companies like Energy Transfer that operate in it, is that fossil fuels are obsolete and doomed to go out of business. Nothing could be further from the truth. Alternative energy sources like wind, solar or bio-energy are not expected to reach enough scale to support the energy needs of the American economy at least until 2040, according to estimates made by the International Energy Agency.
Fossil fuels will remain important energy sources for a very, very long period of time. Although the production share of low-carbon energy sources is expected to grow from 19% in 2020 to 44% by 2040, fossil fuels, for better or worse, are going to remain critical to meet the world’s energy needs.
Energy Transfer is an important investor and operator in the energy industry, owning more than 100 thousand miles of crude oil, refined products, natural gas and NGL pipelines in the United States. Energy Transfer’s pipeline network connects supply basins, for example in the Permian, to terminals and exports hubs along the Gulf Coast.
Natural gas transportation and storage generates the largest income block for Energy Transfer, contributing 27% of EBITDA in Q1’22. Natural gas is followed by Energy Transfer’s midstream business and NGL/refined products segment which contribute 24% and 21% to earnings. Crude oil comes in fourth at an 18% EBITDA share.
Fee-based contracts reduce exposure to raw material price risk
As a midstream company, Energy Transfer generates the majority of its income from fee-based contracts with its counterparts and does not have the same price risks that producers of petroleum or natural gas have. Energy Transfer signs fee-based or take-or-pay contracts with its counterparts in all of its business segments which ensures that the company gets paid a predetermined price. About 90% of Energy Transfer’s expected earnings in FY 2022 are set to come from fees which serves to stabilize the firm’s earnings and cash flow.
Stable distributable cash flow and attractive distribution coverage ratio
Energy Transfer generates stable distributable cash flow — with the exception of Q1’21 where extreme weather conditions swelled the earnings of pipeline operators — and has excellent distribution coverage. The distribution coverage ratio in Q1’22 was 3.36 X indicating that Energy Transfer has sufficient cash flow to meet its distribution requirements.
Distributable Cash Flow For ET Partners
Adjusted Distributable Cash Flow
Distributions (Limited And General)
Distribution Coverage Ratio
Energy Transfer raised its distribution 14.3% in April to a current rate of $0.20 per common unit. Units of Energy Transfer currently pay a yield of 6.9%, covered by distributable cash flow, and Energy Transfer will likely continue to increase its distribution going forward.
NGL export opportunity
Energy Transfer has an opportunity to continue to grow its NGL exports, especially to Europe. Energy Transfer has a 20% market share in NGL exports and Europe’s proposed transition away from Russian energy supplies could be a driver of NGL growth in the future.
Attractive EV/EBITDA ratio
Energy Transfer sees $12.2-12.6B in adjusted EBITDA in FY 2022. Based off of an enterprise value of $93.1B, Energy Transfer trades at a low 7.4 X EV/EBITDA ratio. Kinder Morgan (KMI), which operates in the same business as Energy Transfer, budgets with an adjusted EBITDA of $7.2B this year, implying a EV/EBITDA ratio of more than 10 X. Energy Transfer’s low EV/EBITDA ratio translates to revaluation potential.
Risks with Energy Transfer
Energy Transfer supplies vital raw materials to its energy partners and is therefore a key piece in the U.S. energy system. Fossil fuels will remain important energy sources in the future, but the regulatory climate has deteriorated in recent years with public opinion turning against traditional energy companies. Growing climate change concerns may result in more legislation that could hamstring fossil fuels producers and companies that transport such raw materials. Since Energy Transfer heavily relies on fee-based contracts to generate income, market price risk is not a big risk for the midstream company.
The biggest misconception appears to be that fossil fuels can easily be replaced by alternative, low-carbon energy sources. However, oil and natural gas are expected to remain the most dominant energy sources at least until 2040 which is why midstream companies like Energy Transfer have attractive prospects for long-term growth. What I especially like about Energy Transfer is that the company is not reliant on market prices for its raw materials and that the firm is generating a ton of distributable cash flow that covers its distribution!
Read More: Energy Transfer Stock: Cheap Valuation, Long-Term Potential