Energy

Energy Transfer Stock: Buy This Recession-Resistant Stock (NYSE:ET)

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Energy Transfer (NYSE:ET) increased its distribution to unitholders at the end of July, which brings the distribution yield up to 8.5%. The energy transport company also raised its FY 2022 outlook for its adjusted EBITDA, indicating potential for robust distributable cash flow and dividend growth. Although units of Energy Transfer have revalued 31% higher in 2022, the attractive distribution yield and the firm’s strong distributable cash flow deliver recession protection!

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ET data by YCharts

Energy Transfer: A recession-resistant, fee-based business model

The long-term case for Energy Transfer rests on the expectation that fossil fuels will remain important to the US economy over the next two decades. Fossil fuels, especially crude oil and natural gas, are expected to satisfy about half (48%) of the world’s energy demand by 2040.

Energy Transfer’s business model is build chiefly on fee-based contracts for the delivery of raw materials such as crude oil, refined products, natural gas and NGL. Energy Transfer uses its vast pipeline network to transport raw materials to its customers and in return gets paid a predetermined price for its services which creates high cash flow certainty for the midstream firm and its investors.

Up to 90% of Energy Transfer’s adjusted EBITDA is expected to come purely from fees in FY 2022 which gives the midstream enormous planning security regarding its capital budget, but it also implies that the firm’s cash flow will be reasonably stable. With fee structures and predictable cash flows stabilizing Energy Transfer’s business, the midstream may be an excellent holding during a recession… especially if the company upholds its current rate of distribution growth. Exposure to commodity price exists for Energy Transfer, but fees dominate the midstream’s revenue-generating activities.

Energy Transfer: FY 2022 Adjusted EBITDA Breakdown

Energy Transfer: FY 2022 Adjusted EBITDA Breakdown

Stable cash flow translates to distribution certainty

In Q2’22, Energy Transfer’s adjusted EBITDA and distributable cash flow increased 23% and 35% year over year due to strong performance chiefly in the midstream business. Energy Transfer’s midstream adjusted EBITDA rose 90% year over year to $903M because of increased production in the Permian and South Texas as well as higher margins due to the acquisition of Enable Midstream Partners in FY 2021. Energy Transfer acquired Enable in a $7B deal to grow its natural gas and NGL footprint.

Energy Transfer’s energy assets generate highly predictable cash flow which translates to a reasonably stable distribution coverage ratio. Energy Transfer’s distribution coverage ratio moved between 2.7-3.4 X since Q2’21, although the company increased its distributions to its partners rapidly over the last year.

$millions

Q2’21

Q3’21

Q4’21

Q1’22

Q2’22

Y/Y Growth

Adjusted EBITDA

$2,616

$2,579

$2,811

$3,340

$3,228

23%

Distributable Cash Flow For ET Partners

$1,384

$1,306

$1,440

$2,066

$1,869

35%

Transaction Adjustments

$9

$6

$160

$12

$9

0%

Adjusted Distributable Cash Flow

$1,393

$1,312

$1,600

$2,078

$1,878

35%

Distributions (Limited And General)

$414

$414

$541

$618

$710

71%

Distribution Coverage Ratio

3.36 X

3.17 X

2.96 X

3.36 X

2.65 X

(Source: Author)

Distribution increase

At the end of July, Energy Transfer raised its dividend 15% quarter over quarter to $0.23 per common unit which drove the distribution yield up to 8.5%. Energy Transfer plans to return its unit distribution to the pre-cut level of $0.305 per quarter which implies 33% upside to the current distribution rate.

Energy Transfer chopped its distribution in half in FY 2020 to address its high leverage at the time. If the distribution rate returns to Energy Transfer’s original level, $1.22 per-unit, this means that investors are looking at a distribution yield of 11.3%. At its current rate of growth, Energy Transfer could achieve this within two years, provided that the business keeps expanding and that distributable cash flow is supporting distribution growth.

Energy Transfer raises FY 2022 EBITDA guidance again

The midstream firm expects to generate adjusted EBITDA of $12.6-$12.8B in FY 2022, showing an increase of $400M at the bottom end compared to Energy Transfer’s previous guidance of $12.2-12.6B. The previous guidance itself was raised from $11.8-$12.2B back in May.

Based off of EBITDA expectations, units of Energy Transfer have a valuation ratio of 7.0 X which is much lower than the valuation multiplier factor of Kinder Morgan (KMI), a midstream firm that operates in the same industry as Energy Transfer. Kinder Morgan also grows its distribution only at a 3% annual rate, which is why I believe Energy Transfer is also more attractive from a growth perspective.

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ET Enterprise Value data by YCharts

Risks with Energy Transfer

Because Energy Transfer largely relies on fees to earn its distribution, the midstream firm is not as exposed as other energy companies to a down-turn in the energy industry. However, a massive decline in energy prices and demand during a recession would likely affect the demand for pipeline utilization and storage capacity in which case Energy Transfer may see a decline in its distributable cash flow and distribution coverage ratio.

Final thoughts

Energy Transfer delivered 15% distribution growth in Q2’22 and the distribution coverage ratio remained high at 2.7 X. If Energy Transfer returns its distribution to the 2020 level, investors are looking at 33% distribution growth and a dividend yield exceeding 11%. Energy Transfer also raised its guidance for FY 2022 and the units remain attractively valued based off of EBITDA!

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