Energy Transfer LP has an almost 10% dividend yield

[Bong Hwan Ahn]

Energy Transfer Is Perhaps The Best Trade In An Expensive Market

Feb. 22, 2023 2:10 PM ETEnergy Transfer LP (ET)18 Comments27 Likes

Summary

• Energy Transfer LP has an almost 10% dividend yield along with substantial additional free cash flow beyond that dividend yield.
• The company is continuing to keep growth capital modest, which we like to see, although it's said its debt has hit its targets.
• We'd like to see Energy Transfer LP reduce its debt further, but in the meantime it has the cash flow to generate substantial shareholder returns.
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The market is expensive. The S&P 500 (SP500) is within 20% of its all-time highs. That's despite the fact that there remain substantial structural risks to the market including the Ukraine-Russia war, slowing global growth rates, and the risk of a U.S. default. More so, it ignores the fact that numerous segments of the market (such as tech) were heavily overvalued at the highs.

Despite all of that, there remain gems in the market. Energy Transfer LP (NYSE:ET), as we'll see throughout this article, is one of those gems at this time.

Energy Transfer Changes

Despite continued volatility within the markets, Energy Transfer has continued to perform, with a number of substantial changes.

Energy Transfer Investor Presentation

The company has become one of the largest natural gas operators in the country, building massive fractionation and transportation complexes. The company's Mont Belvieu fractionation volumes have reached more than 1 million barrels / day. The company has continued to set records in each aspect of its business and placed the Gulf Run pipeline into service.

Energy Transfer has announced its 2023 guidance of $13.1 billion in adjusted EBITDA and $1.7 billion in growth capital. We're pleased to see the company is avoiding ramping up its growth capital as it historically has in times of strength. The company's adjusted EBITDA for 2023 is in line with 2022 for the company.

The company's 2022 free cash flow ("FCF") was $7.4 billion, including $4.4 billion after distributions. That's on top of the company's dividend of almost 10%, showing clear double-digit shareholder returns. The company's dividend is almost 9.6% and the company's debt outlook is now positive. The company is within its target leverage, but we'd like to see it lower debt further.

Energy Transfer Growth Capital

The company's growth capital is continuing to be focused on its core businesses.

Energy Transfer Investor Presentation

Energy Transfer's $1.7 billion growth capital will be sent 50% into midstream and 20% into NGL & refined products. That highlights how the company is continuing to focus on its core business aspects. Unfortunately for the company long term, it's keeping investment into alternative energy low, which means an increased chance of long-term risks.

Energy Transfer has several decades to build a business that moves away from the risks of a carbon-heavy business.

Energy Transfer Alternative Energy

The company is working to build an alternative energy business, but it needs to ramp up the scale.

Energy Transfer Investor Presentation

Energy Transfer has slowly worked to take advantage of low carbon to lower its costs. It's ramped up its solar business substantially and is increasingly using renewable fuels. RNG represents a strong holdover business, but it's not a permanent solution from a cost standpoint as renewables see their costs reduce substantially.

The company is taking Exxon Mobil Corporation's (XOM) strategy of using its expertise to reduce carbon emission through fancier technologies such as carbon capture. This technology has substantial potential, but it'll require $100s of billions in investments to achieve the cost basis that it needs to reach.

Energy Transfer Shareholder Return Potential

Energy Transfer has the ability to use its asset base to generate substantial shareholder returns.

We expect the company's 2023 discounted cash flow ("DCF") to be in line with 2022 DCF at roughly $7.4 billion. The company's growth capex guidance is for roughly $1.8 billion, and the company's dividend guidance is for just under $3.8 billion. The total here is $5.6 billion for the company. That means that the company will have $1.8 billion leftover.

Energy Transfer has yet to guide how it'll use that money. Share repurchases or debt paydown could provide substantial shareholder returns. Growth capital or new investments might not. Regardless, with an almost 10% dividend here and continued growth capital, it's clear Energy Transfer has numerous avenues to provide substantial shareholder returns.

Energy Transfer Thesis Risk

The largest risk to our thesis with Energy Transfer is two-fold. The first is that the company has $10s of billions debt, costing the company billions of dollars in annual interest expenses. In a rising interest rate environment, that's dangerous, especially when the company says it's hit its debt targets. The second is long-term changes in the energy markets, for cost alone.

Energy Transfer doesn't have a plan yet to afford predicted changes, and until it does we expect it to struggle.

Conclusion

Energy Transfer LP has a unique and impressive portfolio of assets. The company is expecting to generate equivalent DCF in 2023 and continue its almost 10% dividend yield. On top of that, the company can still be expected to have billions of dollars in additional FCF. It's planning to spend roughly half of that on growth capital.

Going forward, we expect Energy Transfer LP to continue generating core double-digit shareholder returns. We expect it to continue investing in the business. It has the ability to continue generating long-term shareholder returns. We're disappointed to see Energy Transfer LP's lack of investment in a long-term business, however, it's still valuable at this time