As broader markets trade through rough seas, investors could continue looking for high-yielding, safe plays. Energy infrastructure giant Energy Transfer (ET) stock could be one such high-yielding play.
Energy MLPs offer attractive yields. Although they don’t have direct exposure to energy commodity prices, energy MLPs generally have a fair correlation with them. This makes them relatively risky.
Energy Transfer (ET) is currently trading at a distribution yield of 9.4%, one of the highest among its peers. Its historical average yield is around 7%. Also, it offers a yield premium of approximately 700 basis points to the benchmark Treasury yields and the broader markets. The Alps Alerian MLP ETF (AMLP) currently yields around 8.4%. Energy Transfer stock forms nearly 10% of AMLP.
After a distribution cut last year, investors must be eagerly waiting for its distribution to increase. Although it might not happen this year, Energy Transfer’s distribution metrics notably improved in the last few quarters.
The distributable cash flow attributable to partners increased to $1.6 billion in the second quarter. That represented an increase of 23% year-over-year. Its distribution coverage ratio was 2.0x in Q2 2019. Generally, the higher the distribution coverage ratio, the more secure the future distribution.
Energy Transfer’s management sees annual long-term distribution coverage of ~1.7x–1.9x. Its 2.0x coverage ratio and a yield of over 9% makes it an attractive pick among MLPs. Along with yield, distribution growth also plays a vital role in driving investors’ total long-term returns. Energy Transfer’s distribution grew 13.4% compounded annually in the last five years.
Among the other midstream giants, Kinder Morgan (KMI) yields 4.8% while Enterprise Products Partners (EPD) yields 6%. Kinder Morgan’s dividend growth was -14% while EPD’s distribution increased by 5% compounded annually in the same period. AMLP is up about 6% YTD.
The recent acquisition of Semgroup
Energy Transfer’s large debt can be of some concern. Its leverage, measured by net-debt-to-EBITDA ratio, is close to 5.0x, higher than the management’s target. Energy Transfer recently agreed to acquire Semgroup (SEMG) for $5.0 billion. That was a whopping 65% premium.
Investors hammered the stock on the day of the announcement. Also, an acquisition with a high premium can subdue returns when the company is trying to trim down debt.
However, Energy Transfer made it clear that the Semgroup buy would not have any material impact on its debt profile. The acquisition is expected to bolster Energy Transfer’s crude oil transportation and export competencies. The combined entity is expected to save over $170 million in synergies per year.
Energy Transfer’s adjusted EBITDA has increased 17% compounded annually since 2015. It has a large number of growth projects that will could support its premium earnings growth.
Energy Transfer stock has disappointed investors so far this year. As we mentioned earlier, volatile energy commodity prices weighed on the stock, which is trading close to its levels recorded at the start of the year. In comparison, Kinder Morgan is up about 33% while Enterprise Products Partners is up more than 16% so far this year.
Energy Transfer stock: Valuation
Energy Transfer stock is currently trading at a forward PE (price-to-earnings) ratio of 9.0x, notably lower than its historical average PE of 15.0x. This indicates that it is trading at a large discount compared to historical trends. Compared to its peers, Kinder Morgan is trading 20x its forward earnings while Enterprise Products Partners is trading 12x its forward earnings.
So, Energy Transfer looks cheap against its peers as well. Analysts are expecting superior earnings growth from ET for the next few quarters compared to peers. So, a solid yield, discounted valuation, and premium earnings growth makes it stand tall among its peers.
To learn about Energy Transfer’s price targets and technical indicators, read Where Energy Transfer Stock Could Be Headed Now.