Energy Transfer: Attractive 9.5% Yield, But Know The Big Risks

Energy Transfer (ET) offers a big 9.5% yield, and it trades at a very attractive EV-to-EBITDA relative to peers. However, if you’re going to invest, you may want to consider the big risks ET is currently facing (i.e. the price is low and the yield is high for a reason). This article provides an overview of Energy Transfer, reviews the big risks the organization faces, and concludes with our views on whether Energy Transfer is worth considering as an investment.

Overview:

Energy Transfer has one of the largest energy networks transporting natural gas, natural gas liquids, crude oil and refined products through more than 83,000 miles of pipelines spanning the country. The company recently completed a simplification transaction whereby Energy Transfer Equity (ETE) was merged with Energy Transfer Partners (ETP) to create a simplified entity known as Energy Transfer LP (ET). The transaction had multiple benefits, mainly it better aligned partner interests and it improved the financial strength (decreased risk, improved cost of capital) for the combined organization (for example, the transaction resulted in an improved credit rating from S&P—Energy Transfer is rated BBB-, the lower end of investment grade, with a stable outlook).

Energy Transfer is positioned for growth from well positioned assets, organic investments and stronger financials.

Picture1.png

Also very important, Energy Transfer has a diversified earnings mix with primarily fee based business.

Picture2.png

Picture3.png

It is one of the most geographically diverse midstream companies with leading positions in the US.

Picture4.png

However, despite Energy Transfer’s improved leadership position, it still has one of the lowest industry valuations on an EV to EBITDA basis.

Picture5.png

And Energy Transfer’s distribution yield is very high relative to most peers.

Picture6.png

Why Is the Price Low?

Considering Energy Transfer’s yield is so high, its business has improved, and its valuation appears relatively low, why isn’t the market bidding up its price? Shouldn’t investors be willing to pay up for Energy Transfer, thereby driving its price significantly higher? We’ll have more to say about this in a minute, but let’s first consider why the price has gotten so low in the first place.

Picture7.png

Credit spreads (Risk Off): If you’ve been paying attention, the market has sold off since the start of this quarter, with higher risk names leading the charge lower. Energy Transfer falls into the higher risk category for a variety of reasons including uncertainty about the newly combined entity, its relatively high level of debt, its low investment grade credit rating, oil prices, and the uncertainty about its capital expenditures on all of its new growth projects that are not yet online. We’ll have more to say about all of these risks later, but from many market participant’s standpoint, these all combine to make Energy Transfer higher risk, and higher risk securities sell of when credit spreads widen, as shown in the following chart.

1 2 3 4
View single page >> |

Disclosure: We do not currently own Energy Transfer, but may initiate a new position in the coming days.

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.