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Energy Transfer (NYSE:ET) has a well-known history involving ambition, missteps, drama and pain. It is easy to understand why present-day investors might remain suspicious and/or reluctant to own ET units given the long list of chaotic challenges: the failed WMB takeover attempt, the DAPL legal battles, the ME2X delays, the financing controversy, the excessive leverage and the subsequent distribution cut in 2020. The list of disappointments is lengthy.
MLP investments attract a limited universe of investors. Many institutions simply won’t consider investing in partnerships and many retail investors simply won’t consider investing in energy midstream companies. The rapid turnaround that has been taking place at ET and is poised to greatly alter ET’s reputation is, therefore, largely going unappreciated by the majority of professional and retail investors. ET remains a “show me” story still sitting “in the penalty box.” The operational numbers, however, strongly suggest ET is about to successfully transition from an ugly duckling into something of a swan. ET truly offers 50% to 100% upside within a few short years. Let’s look and see why:
While presenting recent Q2 results, ET provided 2022 guidance of $12.7 billion EBITDA, up a few hundred million from its Q1 guidance of $12.4 billion. The dividend distribution was raised and debt declined while management expressed a continued focus on reaching FID for the Lake Charles LNG exporting facility by year-end. Other projects were also briefly discussed such as ET’s continued interest in a pan Panamanian pipe project, a NG take-away capacity expansion project in the Permian Basin, expansion into more petrochemical processing capacities and more potential with what can be done with the ME2x complex in PA. Energy Transfer clearly believes there are plenty of growth opportunities and is not shy about wanting to build and buy itself into a larger company, perhaps by the tune of investing $3 to $4 billion per year in projects and acquisitions.
Wanting to grow and identifying attractive opportunities is fine, but what really gets exciting about the ET story is the fact that ET is generating so much money, it can easily invest $3 to $4 billion to grow, while it also pays down its debt burden and raises its dividend distribution significantly. In fact, this is precisely what is happening right now.
Currently, ET pays out roughly $2.5 billion in interest on its $49 billion of debt. ET also spends roughly $500 million per year on maintaining its current portfolio of assets. Subtract these two numbers from its EBITDA of $12.7 billion for 2022 and ET still has $9.7 billion. If we assume ET elects to invest $4 billion a year going forward in new projects and acquisitions, that still leaves us with $5.7 billion for debt reduction and capital returns to investors. The important point is this: ET can invest $4 billion a year for growth and still pay out almost $1.90 a unit if management wanted to do so. In other words, the current distribution could rise over 100% from its current run rate of .23 per quarter or .92 cents per year.
ET management has already told us they intend to raise the dividend as rapidly as possible back to the $1.22 level or higher. Given that ET management has already raised the distribution for three quarters in a row, and given just how much excess cash ET is generating, we are forced to assume that the distribution is going to reach the prior $1.22 by May of 2023 (mas o menos). But once the distribution is back up to $1.22/unit or $3.66 billion then what happens?
Management has slashed debt by nearly $7.5 billion in the past two years and all evidence suggests they fully intend to continue using some of the excess cash to lower their leverage even further. Use your own numbers if you don’t agree with mine, but make sure you figure out a way to use up all that excess cash flow. Either debt is going to drop by $2 billion a year or large buybacks and dividend hikes are more or less a sure thing.
Again: $12.7 billion EBITDA – $2.5 billion Interest – $500 million maintenance = $9.7 billion. Then subtract $3 to $ 4 billion for new projects with “hoped for” ROIs of 12%+ potentially making ET $360 to $480 million a year in more EBITDA. $9.7 billion – $3 billion = $6.7 billion a year or $2.23 a share to either strengthen the balance sheet and lower leverage or for higher distributions and buybacks.
If you approve of the projects ET appears to be pursuing and you are willing to wait and watch these projects reach fruition, then you might also be willing to assume that ET surpasses $13 billion EBITDA in the next few years. If you assume ET ought to be content with its balance sheet as leverage declines below 4.0 then you also ought to assume a time shall come when ET is no longer compelled to focus on reducing its debt burden. If these conditions seem reasonable to you, then you likely must accept that ET is on its way toward earning $13 billion in EBITDA while it keeps spending about $3 billion on Interest and Maintenance and another $3 billion+ on new projects. After these expenses and investments, ET will still have roughly $7 billion to allocate toward dividend distributions and buybacks. $7 billion equates to over $2.33 for capital returns to shareholders. One might suggest an ET with a leverage ratio below 4.0 paying out $2.33 per unit might be worth $25 a unit? Hard to believe from here, but not really so crazy as it first sounds.
None of us yet know what ET is going to do with all its excess cash flow. Perhaps they squander some of it, perhaps the story does not play out nearly as well as the numbers here suggest they could. Still, at $11.70 a unit with the dividend rising and the debt burden declining, the probability of a happy performance from here is very strong. A lot can go wrong and we shall still earn well over 50% within the next 3 years.
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