Energy Transfer LP: This 10.7% Yield’s No Joke
Looking for a Double-Digit Yield? Read This
Hunting for yield is not easy in today’s low-interest-rate environment.
Any stock that pays more than five percent is going to get put under the microscope, and if it’s anything solid, investors will rush to buy it, bid up its price, and cause its yield to drop.
Therefore, if a company’s yield stays at a high level, it’s usually an indication that something is wrong.
And that’s why I usually tell risk-averse income investors to stay on the sidelines when it comes to ultra-high-yielders. In this day and age, no one wants to learn the costly lesson of buying a stock before it cuts its dividend.
But there are always exceptions. Every once in a while, you may come across a high-yield stock that can actually cover its payout.
An Energy MLP Income Investors Shouldn’t Ignore
Case in point: Energy Transfer LP (NYSE:ET). This is a master limited partnership (MLP) headquartered in Dallas, Texas.
The partnership makes quarterly cash distributions of $0.305 per unit. With ET stock trading at $11.39 apiece, the quarterly distribution rate comes out to an annual yield of 10.7%.
Now, given what most of the other companies are offering at the moment (much less), you might be wondering how Energy Transfer LP can afford this level of payout.
Well, the partnership operates in the midstream energy business.
While ET is not exactly a trendy ticker, it owns and operates one of the largest and most diversified portfolios of energy assets in the U.S., including natural gas midstream, intrastate, and interstate transportation and storage assets; crude oil, natural gas liquids (NGL) and refined product transportation and terminaling assets; NGL fractionation assets; and various acquisition and marketing assets.
The energy industry is known for being volatile. That’s one of the reasons why a high-yield energy stock can look particularly risky.
However, while Energy Transfer LP is a heavyweight player in the energy sector, it runs a business that’s largely fee-based.
For instance, the partnership’s Bakken crude oil pipeline is supported by long-term, fee-based contracts.
And, in ET’s “Interstate Natural Gas Transportation & Storage” segment, around 95% of revenue is earned from reservation fee contracts. (Source: “Investor Presentation November 2019,” Energy Transfer LP, last accessed November 20, 2019.)
At the same time, the partnership has a diversified customer base that includes producers, midstream providers, and major integrated global oil companies.
So, thanks to a fee-based business model and a diversified customer base, Energy Transfer LP can generate a predictable stream of cash flow despite commodity price volatility.
Is the Distribution Safe at Energy Transfer LP?
Of course, as is the case with most MLPs, in order for Energy Transfer LP’s distribution to be considered safe in a given reporting period, it needs to generate distributable cash flow that is in excess of its payout.
The partnership reported earnings earlier this month. In the third quarter of 2019, Energy Transfer LP generated $1.5 billion in distributable cash flow. The amount represented a $137.0-million increase from the year-ago period. (Source: “Energy Transfer Reports Solid Third Quarter 2019 Results,” Energy Transfer LP, November 6, 2019.)
To put that in perspective, the partnership is paying $809.0 million in total cash distributions for the quarter. As a result, it achieved a distribution coverage ratio of 1.88 times, meaning the MLP generated 88% more cash than what was needed to fulfill its distribution obligations.
In the first nine months of this year, Energy Transfer LP earned $4.8 billion in distributable cash flow. Its actual cash distributions, on the other hand, totaled $2.4 billion for this period. Therefore, the distribution coverage ratio arrived at an even higher 1.98 times, meaning ET covered its payout nearly twice over.
If you’ve been following high-yield energy stocks, you’ll know that dividend safety is a common concern. Yet, despite being one of the highest yielders on the market, Energy Transfer LP has no problem covering its oversized cash distributions.
And because of its strong distribution coverage, the partnership has accumulated quite a bit of excess cash, which can be invested in its growth projects.
“Distribution coverage for the quarter was 1.9x which resulted in excess cash flow after distributions of $712 million for the quarter. Year-to-date our excess cash flow after distributions totaled approximately $2.4 billion. This excess cash flow plus the Series E preferred units issued in April has allowed us to fund year-to-date growth capital expenditures without the issuance of common equity or debt,” said Energy Transfer’s Chief Financial Officer Thomas Long in the latest earnings conference call. (Source: “Energy Transfer LP (ET) Q3 2019 Results – Earnings Call Transcript,” Seeking Alpha, November 7, 2019.)
Combining a fee-based business, strong distribution coverage, and a double-digit yield, Energy Transfer stock looks like an opportunity for income-seeking investors.