After several tough years, Energy Transfer Partners (NYSE: ETP) finally seemed to turn the corner last quarter. The pipeline company reported that distributable cash flow not only stopped sliding but surged 21.5% to $990 million after several expansion projects entered service. Thanks to that, and a little help from parent company Energy Transfer Equity (NYSE:ET), it covered its distribution to investors with room to spare.
But despite the improving financials, Energy Transfer Partners' unit price is down more than 35% over the past year. As a result, the company trades at a ridiculously cheap valuation and yields an eye-popping 11.8%. A couple of weights are behind its depressed price; if they are lifted, unit price could soar.
A big buyback from its sibling
One of Energy Transfer's biggest problems is finding the financing for its massive slate of capital projects. The company expects to spend $3.9 billion this year on expansions, with $2.2 billion of that to be funded over the second half of the year. The company recently issued $1 billion in new units and $2.25 billion in additional debt to refinance higher-cost debt and pay down its credit facility so it would have the liquidity to fund these projects. However, it has planned more spending ahead in 2018, which is weighing on units since the market doesn't know where the company will get that capital.
One possible option is to monetize its stake in sibling company Sunoco LP (NYSE:SUN) that it received as part of the payment for a series of dropdown transactions. Energy Transfer currently owns 43.5 million units that are worth about $1.35 billion. Sunoco, however, recently announced the sale of the bulk of its retail assets to 7-Eleven in a $3.3 billion deal. While the company plans to use most of those proceeds to pay down debt, it could use a portion to repurchase equity, including the units owned by Energy Transfer. The pipeline giant believes it could bring in as much as $1 billion in cash by participating in a buyback, which would help plug its funding gap. The company could eventually divest any remaining units at a higher valuation and bring in more cash in the future if Sunoco's plan succeeds at unlocking value.
An unexpected change in the family structure
Another issue holding the company down is the expensive incentive distribution rights (IDR) owned by Energy Transfer Equity. Last quarter, for example, those IDRs entitled Energy Transfer Equity to 40% of Energy Transfer Partners' distributable cash flow. The parent company relinquished some of those rights to help support the pipeline company through its current building phase, but that support will start diminishing next year.
These types of payments have become too much for many of Energy Transfer's peers to bear, which is why most have undertaken transactions to eliminate them. For example, Williams Companies (NYSE:WMB) and Williams Partners (NYSE: WPZ) completed a financial repositioning transaction earlier this year, according to which Williams permanently waived its IDRs in exchange for more units of Williams Partners. One of the benefits of that deal is that it has improved Williams Partners' cost of capital so it can raise money in the markets at a cheaper rate.
While Energy Transfer Equity has said it would evaluate an optimal structure for the family, it doesn't expect any internal restructuring transaction to occur before late 2019 since it has plenty on its plate right now, namely a large slate of expansion projects currently underway. However, Energy Transfer Partners CEO Kelcy Warren stated on last quarter's conference call that the company would look at doing an interim step sooner. A workable solution that alleviates the IDR burden would lift a weight that could push the company's valuation closer to the average of its unburdened peers.
Waiting for action
Energy Transfer's primary focus these days is on completing its massive backlog of high-return growth projects, which it believes will fuel significant earnings and cash flow growth. Even so, there are a couple of things it could do in the interim that might help reduce some of the pressure holding down its valuation. The lifting of those weights could richly reward investors who are bold enough to buy amid the uncertainty.