After remaining revved up in the third quarter, Energy Transfer Partners' (NYSE: ETP) growth engine should have stayed in high gear during the fourth quarter. The expansion projects the company completed earlier in the year should have kept the momentum going and driven earnings and cash flow higher. That continued growth is one of several things investors should keep an eye on when the company reports results Wednesday evening.
Look for its financial results to improve significantly
Energy Transfer Partners' rough patch finally came to an end in the second quarter. Earnings and cash flow turned the corner and then continued ascending in the third quarter. Multiple factors drove the company's rebound last year, including the completion of several expansion projects and a couple of acquisitions, as well as an improvement in the oil and gas market, which fueled higher volumes across its systems. These catalysts should have remained in full force during the fourth quarter.
One of the drivers in the third quarter was Energy Transfer's recently completed Bakken Pipeline, which helped more than double the earnings in the company's crude oil transportation and services segment. We know from one of the system's co-owners, Enbridge Energy Partners (EEP), that the pipeline operated well during the fourth quarter. Enbridge Energy Partners noted that earnings from its Bakken assets rose more than 50% during the quarter thanks mainly to the start-up of this system earlier in the year. In addition to that project, Energy Transfer also completed two of the three phases of its Rover Pipeline last year, which should help provide a boost in the fourth quarter. As a result of these project completions, the company should deliver double-digit earnings and cash flow growth in the fourth quarter.
Keep an eye on the coverage ratio
Thanks to those expansion projects, Energy Transfer's cash flow has increased and helped significantly improve the sustainability of the company's 12.2%-yielding distribution. At the end of 2016, the coverage ratio was 0.89 -- meaning the company distributed more cash to investors than came in -- but it improved to a much more comfortable 1.13 in the third quarter of 2017.
That said, another factor boosted that metric: Energy Transfer's parent, Energy Transfer Equity (ET 0.40%), provided it with some additional support by giving up a portion of its management fees. Without that support, Energy Transfer Partners would have paid out $39 million more than it pulled in last quarter. Under the terms of the revised agreement, Energy Transfer Equity's support increased by $10 million last quarter to $173 million, which will have provided more breathing room. However, to ensure the long-term sustainability of its lucrative payout, Energy Transfer needs to be able to fully cover it with cash flow, which is why investors should do the math and see if the company achieved that aim in the fourth quarter.
Watch for more improvements to its financial situation
Because Energy Transfer pays out virtually all its cash flow to investors, the company must secure outside capital to finance its massive $10 billion expansion project backlog. This pursuit has proved challenging: The company hasn't been able to access the debt and equity markets as freely in recent years, because its unit price has plunged due in part to an already hefty amount of debt.
The company has been working hard to reduce debt over the past year and had trimmed its leverage ratio from 5.74 at the end of 2016 to 4.92 at the end of last quarter. While that's progress, it's still a long way from its target level of 4. That said, the company is in the process of completing several strategic transactions to improve its balance sheet, including issuing some preferred equity and closing the sale of a stake in its Rover Pipeline to a private equity fund during the quarter. And the company has more transactions in the pipeline, including selling its compression business and some of its stake in Sunoco LP. These transactions should help get the company closer to its leverage goal while also providing funding to keep expanding. Investors should keep an eye out for what else the company plans to do this year to achieve both goals.
Expect another step forward
One reason Energy Transfer Partners' yield is still in the double digits is that investors remain concerned about both its coverage ratio and balance sheet. The company can help alleviate some of those concerns by posting improving numbers in the fourth quarter while also laying out the road map on how it plans to finish the task. If Energy Transfer can do all that this week, it would boost investor confidence that the company's sky-high yield can survive.