Earlier this month, Sunoco Logistics Partners (NYSE:SXL) agreed to acquire its sibling, Energy Transfer Partners (NYSE:ETP), in a unit-for-unit deal. That said, while Sunoco was the acquiring entity, the combined company will retain the Energy Transfer name. That's because the deal was not about growing Sunoco, but using it as a vehicle to quickly and efficiently get Energy Transfer Partners back into shape.
Given that focus, here are three things investors can expect from the new Energy Transfer going forward.
A better balance sheet
One of the most important things this transaction addresses is Energy Transfer's concerning leverage situation. After spending billions on growth projects and distributing more to investors than it brought in, Energy Transfer's debt has grown to the point where the company could lose its investment-grade credit rating. While there were no easy fixes to that problem, the company saw a merger with Sunoco as a way to get the company's debt metrics "into shape quicker," according to comments by Matt Ramsey, the COO of parent company Energy Transfer Equity (NYSE:ET), on the conference call discussing the transaction.
In fact, as a result of the deal, the pro forma company's debt-to-EBITDA ratio will be slightly less than 5.0 times. That number, according to comments by Energy Transfer Partners CFO Tom Long on the call, is "a big improvement." Driving that change is the fact that Sunoco has a much lower leverage profile, with its debt-to-adjusted EBITDA at 3.6 times as of the end of the third quarter. Combining the two brought down Energy Transfer's leverage.
That said, the company is not planning to stop there, aiming to get that metric below 4.0 times in the next 12 to 18 months. The improvement in the leverage ratio should ensure that the company maintains an investment-grade credit rating, which would keep its borrowing costs from going higher.
A stronger coverage ratio
One of the ways the company is going to start pushing leverage down is by no longer paying out more than it brings. That's due in part to the fact that the deal will result in a back-door reduction in Energy Transfer Partner's distribution to investors. Energy Transfer Partners needed to make that cut because it has only earned $0.87 for every dollar it paid out to investors this year, which is clearly not a sustainable practice. That gap between cash flow and distributions came despite the fact that Energy Transfer Equity supplied it with an increasing level of support by relinquishing a growing portion of its incentive distribution rights.
Sunoco, on the other hand, has generated more money than it paid out this year by maintaining a distribution coverage ratio above 1.0 times. So, merging with Energy Transfer and keeping the Sunoco distribution rate strengthens the distribution coverage ratio of the entire entity.
Going forward, investors can expect Energy Transfer to maintain a greater than 1.0 times coverage ratio. That is clear from comments by company founder and CEO Kelsey Warren, who lamented on the call, "I don't want to go below a 1.0 times coverage ratio, again, in my career. That was not a good ride."
An improved growth profile
While Energy Transfer Partners' investors do need to endure a significant near-term distribution cut to accomplish these goals, the transaction puts the company in the position to deliver stronger growth going forward. That's because a stand-alone Energy Transfer would likely have needed to redirect most of its growing stream of cash flow from new projects toward debt reduction and to strengthening the coverage ratio instead of increasing the distribution.
However, this deal accomplishes both of those goals with room to spare. Because of that, the combined entity can deliver low double-digit distribution growth in the near term. Further, it positions the combined company to capture additional growth opportunities because it should have greater access to low-cost capital to make acquisitions and invest in new growth projects.
Energy Transfer saw a chance to address three fundamental problems in a quick and efficient manner by merging with its sibling. While it is the target company of the deal on paper, in the end, its name will live on, and its management team will remain in control. However, by structuring the deal the way they did, Energy Transfer will emerge a much stronger company, which positions it for success in the years ahead.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.