Published on June 12th, 2017 by Nicholas McCullum
Income investors are starved for yield in today’s investing environment. It’s not hard to see why:
- The 10-year government bond yield is ~2.2%
- Many sovereign entities have zero (or below!) yields on their outstanding debt. For instance, Japan’s (the world’s third largest economy by GDP) 10-year government bond has a yield to maturity of 0.05%.
- The average dividend yield of the S&P 500 is 1.9%, driven down by high equity valuations
Thus, when a company like Energy Transfer Equity is paying a 7.0% dividend yield, investors tend to take notice. There are currently very few companies that offer the same combination of yield and relative safety as Energy Transfer Partners.
With that said, you can see the full list of 416 companies with 5%+ dividend yields here.
Energy Transfer Partners’ high dividend yield, strong dividend history, and robust growth prospects helped it to rank as a top 10 stock in the most recent edition of the Sure Retirement newsletter.
This article will analyze the investment prospects of Energy Transfer Equity in detail.
Energy Transfer Equity is essentially an investment holding company with stakes in some of the most well-known master limited partnerships.
The company’s business model is summarized succinctly in the following quote from their most recent 10-K.
“The Parent Company’s principal sources of cash flow are derived from its direct and indirect investments in the limited partner and general partner interests in ETP and Sunoco LP, both of which are publicly traded master limited partnerships engaged in diversified energy-related services, and the Partnership’s ownership of Lake Charles LNG.”
Source: Energy Transfer Equity 2016 10-K, page vi
Until recently, the company also had a significant tertiary interest in Sunoco Logistics (SXL), since Energy Transfer Partners owned the general partners of SXL as well as a significantly limited partner stake.
The company’s legacy business model can be seen below.
Source: Energy Transfer Equity 2016 10-K, page 1
However, this organizational structure has recently changed.
In late April, Energy Transfer Partners merged with Sunoco Logistics. The new entity continues to hold the name Energy Transfer Partners and trades at the price and yield of the legacy Sunoco Logistics security.
This simplified the ownership structure of the Energy Transfer family of companies and prevented a likely distribution cut at the ‘legacy’ Energy Transfer Partners.
The new corporate structure of Energy Transfer Equity can be seen below.
In the midstream MLP space, Energy Transfer Equity’s ownership structure is quite unique and gives the parent company access to a wide number of energy industries.
Specifically, Energy Transfer Equity has exposure to natural gas, natural gas liquids (NGLs), and crude oil via a high-quality asset base that transports a staggering amount of product each day.
The company also has an enviable geographic footprint.
Through Energy Transfer Partners and Lake Charles LNG, Energy Transfer Partners has a stake in many pipelines and other midstream assets in the southern and eastern United States.
Further, the company has a stake in 1,000+ retail convenience stores and gas distribution outlets through its stake in Sunoco, LP (though Sunoco is currently under contract to sell many of its stores to 7-Eleven).
Moving on, the next section will discuss the growth prospects of Energy Transfer Equity in detail.
Energy Transfer Equity’s most compelling growth prospects comes from the underlying growth of Energy Transfer Partners in the wake of its recent merger.
The merger expanded the strategic footprint of Energy Transfer Partners and has created what is estimated to be the largest midstream MLP based on EBITDA and the second-largest midstream MLP based on enterprise value.
More details about the growth prospects of Energy Transfer Partners post-merger can be seen below.
One compelling aspect of the merger between Energy Transfer Partners and Sunoco Logistics is the expected cost synergies.
Through the removal of duplicate roles, complimentary asset combinations, and a more efficient tax structure, the ‘new’ Energy Transfer Partners is expected to realize annual cost savings in excess of $200 million annually by 2019 over its previous, separated business model.
It should be noted that the Energy Transfer Equity entities often work together and additional business combinations are highly likely. The Chief Executive Officer of Energy Transfer Partners, billionaire Kelcy Warren, said on a recent conference call that “I think an ultimate consolidation is inevitable.”
Competitive Advantage & Recession Performance
Energy Transfer Equity’s largest competitive advantage comes from its financial strength thanks to working alongside Energy Transfer Partners and Sunoco, LP.
As mentioned, these companies often work together in the best interests of their shareholders, which minimizes the chances of poor performance or a distribution cut at any individual entity.
With that said, Energy Transfer Equity’s distribution coverage ratio declined to 0.86 in the most recent quarter. This is lower than we’d like but has an identified cause that alleviates any concerns about the MLP’s ability to pay future dividends.
Energy Transfer Equity has temporarily reduced the IDRs it received from Energy Transfer Partners. Energy Transfer Equity had previously announced that it had agreed to a temporary IDR reduction of $720 million over a period of 7 quarters beginning in June of 2016.
The purpose of this is to allow ETP to focus on current growth projects. While this elevates ETE’s risk right now (and for the near future) a distribution cut is unlikely since the Energy Transfer family is more likely to resume ETP’s IDR payments than cut ETE’s dividend. ETE’s last dividend increase was in 2015 and the MLP is unlikely to deliver immediate dividend growth given its low distribution coverage ratio.
ETE’s last dividend increase was in 2015. The MLP is unlikely to deliver immediate dividend growth given its low distribution coverage ratio. With that said, the company’s dividend growth should resume in March when the agreed-upon IDR reduction expires.
With regards to recession resiliency, I would expect ETE to perform well during future economic recessions because of its track record during the global financial crisis of 2007-2009. While many larger companies were freezing or reducing dividends, Energy Transfer Equity paid increasing dividends. The company is more sensitive to downturns in commodity prices than changes to the broader economic environment.
Valuation & Expected Total Returns
Energy Transfer Equity’s future shareholder returns will come from valuation changes, the MLP’s current dividend yield, and growth in the company’s distributable cash flow.
As an oil & gas MLP, Energy Transfer Equity cannot be meaningfully analyzed using traditional valuation metrics such as the price-to-earnings ratio. The most useful valuation tool for assessing MLPs is to compare their current dividend yield to their historic dividend yields.
Energy Transfer Equity currently pays a quarterly dividend of $0.285 which yields 7.0% on the company’s current stock price of $16.50.
The following diagram compares the MLP’s current dividend yield to its historical averages.
Since inception, Energy Transfer Equity has traded at an average dividend yield of 5.7%. The company’s current dividend yield of 7.0% indicates that it is moderately undervalued at current prices.
Turning to distribution and funds from operations growth, the MLP will likely continue to distribute most of its funds from operations to shareholders. Thus, profitability growth will be closely tracked by growth in the company’s per-share distribution payments.
Over the past decade, Energy Transfer Equity has grown its per-share distributions at a rate of ~13% per year.
The company’s quarterly dividend history can be seen below.
Looking ahead, I believe that the MLP’s growth will likely slow, and investors can conservatively expect 4%-6% growth in the company’s distribution once IDR payments are continued from Energy Transfer Partners.
While 4%-6% distribution growth is much slower than the company’s historical average, investors still have a very high likelihood of double-digit total returns, composed of:
- 7.0% dividend yield
- 4%-6% distribution growth
For expected total returns of 11%-13% before the (likely positive) impact of valuation changes.
Energy Transfer Equity has many of the characteristics of a solid investment:
- Above-average dividend yield
- Shareholder-friendly management
- A strong growth record
All of these factors help the company to rank favorably using The 8 Rules of Dividend Investing, which allowed Energy Transfer Equity to rank as a Top 10 stock in the most recent Sure Retirement newsletter.
Thus, Energy Transfer Equity is a buy at current prices.