Energy Transfer LP: Earn a 30% Yield From an Energy Stock?
ET Stock Offers a Jaw-Dropping Payout
With the latest downturn in oil prices, energy stocks have been heavily sold off. As a result, their dividend yields have climbed.
Of course, beaten-down high yielders aren’t really known for their dividend safety. But if you know where to look, you just might find a down-and-out energy stock with an oversized, yet reliable, payout.
Case in point: Energy Transfer LP (NYSE:ET), which is a master limited partnership (MLP) headquartered in Dallas. Like many tickers in the energy industry, Energy Transfer stock had a major fall recently. And due to the inverse relationship between dividend yield and stock price, the tumble in ET stock has boosted its yield to a jaw-dropping level.
Trading around $4.00 per unit at the time of this writing, the partnership offers investors an annual distribution yield of about 30%.
Now, you are probably wondering how this energy partnership will do, given the slide in oil prices. Well, the first thing to note is that, while Energy Transfer LP has a strategic footprint in all of the major production basins in the U.S., its focus is on the midstream sector. The partnership’s core operations include the transportation, storage, and terminaling of crude oil, natural gas, natural gas liquids (NGL), refined products, and liquid natural gas.
The neat thing about being a midstream operator is that the business is largely fee-based. In the case of Energy Transfer, the partnership also has take-or-pay contracts, reserved capacity, and minimum volume commitments that add stability to its business.
According to the company’s latest investor presentation, management expects fee-based operations to account for 85% to 90% of the partnership’s gross margin in 2020. (Source: “Investor Presentation February 2020,” Energy Transfer LP, last accessed March 18, 2020.)
By running a fee-based business, Energy Transfer can limit its exposure to commodity price movements.
Just take a look at the MLP’s distributions during the last commodity price downturn and you’ll see what I mean.
For the first quarter of 2014, Energy Transfer paid a cash distribution of $0.1794 per unit (split adjusted). Then came the massive crash in oil and gas prices in the summer of 2014. But during the height of the crisis, Energy Transfer was actually raising its payout. Today, the MLP has a quarterly cash distribution rate of $0.305 per unit, marking a 70% increase over the past six years. (Source: “Distribution History,” Energy Transfer LP, last accessed March 18, 2020.)
Of course, past performance does not guarantee future results. But if you take a look at ET’s financials, you’ll see that the partnership has actually left a wide margin of safety in its distribution policy.
Energy Transfer LP: Is the Distribution Safe?
Energy Transfer reported its fourth-quarter 2019 results on February 19, 2020. The report showed that the partnership’s distributable cash flow grew two percent year-over-year to almost $1.6 billion in the fourth quarter. Since the MLP paid total cash distributions of $821.0 million for the quarter, it had a distribution coverage ratio of 1.9 times. (Source: “Energy Transfer Reports Solid Fourth Quarter 2019 Results,” Energy Transfer LP, February 19, 2020.)
In other words, Energy Transfer generated 88% more cash than what was needed to fulfill its distribution obligations for the quarter. That should give the MLP quite a bit of financial wiggle room, meaning, even if business slows down, there’s a good chance that the company can still cover its payout.
Looking at full-year 2019, we see that the partnership generated $6.3 billion of distributable cash flow. Its actual cash distributions, on the other hand, totaled 3.2 billion for the year. As a result, Energy Transfer LP achieved a distribution coverage ratio of 1.96 times, indicating that the company covered its payout nearly twice over.
If you’ve been following MLPs, you’d know that, among the ultra-high-yielding ones, it’s quite rare to see a distribution coverage as strong as this.
Furthermore, Energy Transfer is not standing still. In 2019, the partnership completed quite a few growth projects.
For instance, its “Red Bluff Express Pipeline” Phase II was completed in August 2019, the “J.C. Nolan Pipeline” went into service in August 2019, and the “Permian Express 4 Pipeline” went into full service in October 2019. Note that the MLP has a slate of projects that are expected to be completed in 2020. As more assets become operational, Energy Transfer could get a solid boost in its financials.
Bottom Line on Energy Transfer LP
At the end of the day, it’s hard to say how long the downturn in oil prices will last or when investors will turn bullish toward energy stocks (including Energy Transfer stock) again.
But given what Energy Transfer LP has been doing, the partnership is well positioned to keep delivering oversized distribution checks to its unitholders.