What’s Next for Energy Transfer Stock and Its 8% Dividend Yield?

Since the start of 2022, Energy Transfer (NYSE: ET)has increased its distribution every quarter. However, everything has not always been smooth for the company. In fact, back in 2020, the midstream company slashed its distribution in half.

So, what’s in store for Energy Transfer’s stock and its distribution? First, let’s first look at what the company does and how it grows its distribution.

A midstream giant

Energy Transfer is an integrated midstream company that transports hydrocarbons such as natural gas, natural gas liquids (NGLs), crude oil, and refined products. The company’s operations expand the midstream spectrum from gathering and processing to fractionation, storage, and transport. The company also owns stakes in motor fuel distribution company Sunoco LP and USA Compression Partners, which provides natural gas compression services. Energy Transfer is structured as a master limited partnership (MLP), so investors will get a K-1 and have unique tax advantages (and obligations).

Approximately 90% of Energy Transfer’s 2024 earnings before interest, taxes, depreciation, and amortization (EBITDA) is projected to come from fee-based activities. Fee-based businesses are not directly impacted by commodity price changes or commodity spreads and, thus, tend to be more consistent and predictable. This is important for income-oriented energy investors, as it generally means that a midstream company’s distributions are more sustainable.

Energy Transfer’s huge integrated system also allows it to be one of the largest energy arbitrageurs in the U.S. The company can take advantage of geographic and seasonal differences to boost both its results and those of its customers. This can be done in a few ways, such as selling natural gas, which has very regional pricing, into a market with better pricing or by storing hydrocarbons to get a better price in the future. It can also upgrade NGLs to higher-value products.

Overall, Energy Transfer is well positioned to be a steady performer throughout different commodity cycles, given that it is involved in predominantly fee-based activities that are diversified across product types. Its assets also allow it to find the best times and places to sell the hydrocarbons it transports.

Image source: Getty Images.

Growth opportunities

Energy Transfer has built out one of the largest midstream networks in North America through a combination of organic growth projects and acquisitions.

The company is looking to spend between $2 billion to $3 billion a year in growth capex over the next several years. Importantly, Energy Transfer can fund these projects solely through the cash flow it generates after it pays its distributions. In 2023, it generated $7.6 billion in distributable cash flow and paid out nearly $4 billion in distributions to unitholders. That should give it plenty of room to spend on growth projects.

This is important for investors because it allows the company to pay out its distribution while still being able to pay down debt. When Energy Transfer cut its distribution in 2020, it was because its leverage became too high, and it needed to pay down debt. After getting its leverage down, it was able to not only return its distribution to pre-cut levels, but its quarterly distribution of 31.5 cents is now higher than the 30.5 cents it was before the distribution cut.

This year, Energy Transfer is projecting to spend between $2.4 billion to $2.6 billion on growth projects. Historically, midstream companies have targeted 6 to 8 times returns on growth capex, so, once complete, these projects should add around $350 million a year in cash flow. This growth can then be used to increase its distribution to unitholders.

More upside ahead

Energy Transfer’s distribution is currently well covered by its cash flow, with the company generating free cash flow after distributions of about $3.6 billion in 2023. Even with growth capex set to increase from $1.6 billion in 2023 to about $2.5 billion this year, its distribution coverage ratio will still be rock-solid. Together with its largely fee-based business model and a strong backlog of growth projects, the company looks poised to continue to grow its distribution over the next several years.

ET EV to EBITDA (Forward) Chart

ET EV to EBITDA (Forward) data by YCharts

On top of that, Energy Transfer is one of the cheapest large-cap stocks in the midstream sector. I typically use an enterprise value-to-EBITDA multiple to value midstream stocks. The reason is that enterprise value takes into account things like net debt, while EBITDA backs out non-cash items like depreciation.

If Energy Transfer were trade at valuations closer to its MLP peers, it could have a lot of price upside ahead. Now one of the reasons Energy Transfer has traded at a discount to its peers is because it was not always the most shareholder friendly company when its general partner (GP) and limited partner (LP) traded as two entities, and the company lost some investor trust when it cut its distribution.

However, Energy Transfer’s GP and LP merged into one company back in 2018, eliminating the conflicts of interest that previously existed, and since the distribution cut in 2020, the company has improved its balance sheet and has been able to restore its distribution back to pre-cut levels. While it will take time for investor trust to be restored, given its improved balance sheet, growth prospects, and the current path of its distributions, Energy Transfer should be able to win back investors over time.

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Geoffrey Seiler has positions in Energy Transfer, Enterprise Products Partners, Sunoco, and Western Midstream Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.

What’s Next for Energy Transfer Stock and Its 8% Dividend Yield? was originally published by The Motley Fool