Energy Transfer (ET 0.45%) is one of the higher yielding large-scale master limited partnerships (MLPs), with a yield at slightly more than 8%, which makes it attractive to income-focused investors. However, before dividend-seekers buy it for the dividend, they need to make sure that it's safe for the long haul. Otherwise, they could see that income stream run dry.
Here's a closer look at the safety and long-term sustainability of Energy Transfer's above-average dividend.
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Drilling down into Energy Transfer's dividend safety
The best high-yield dividend stocks have three things in common: They generate relatively stable cash flow, have a conservative dividend payout ratio, and a strong balance sheet backed by a relatively low leverage ratio. Energy Transfer currently fits all of that criteria. For starters, about 90% of the company's earnings come from stable sources like fee-based contracts. While the company does have some exposure to volume fluctuations and commodity prices in its midstream businesses, most of its assets generate steady fees, which gives it a solid foundation of cash flow with which to pay its dividend.
Energy Transfer also has a conservative dividend payout ratio. During the third quarter, Energy Transfer only distributed 58% of its cash flow to investors, which worked out to a 1.73 times coverage ratio. Not only was that an improvement from 1.59 times in the year-ago quarter, but it was right up there with its conservative peer Enterprise Products Partners (EPD 0.48%) -- which had a 1.7 times coverage ratio during the same quarter -- and well above the 1.2 times comfort zone of most MLPs.
Finally, Energy Transfer also passes the balance-sheet test. While the company's financials deteriorated during the oil market downturn, its key metrics have dramatically improved in the past year. The company's leverage ratio, for example, has gone from a worrisome 5.54 times debt to EBITDA at the end of last year's first quarter to a much safer 4.0 times for 2018. That's on par with the comfort level of most MLPs, though it's not quite as good as Enterprise Products Partners, which has had an average leverage ratio of 3.6 times so far in 2018.
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A look at its long-term sustainability
Those numbers make it clear that Energy Transfer's high-yielding dividend is currently on rock-solid ground. However, what's equally important is if the company can sustain this over the long term. While it's impossible to predict the future, we can get a glimpse of what might be ahead by looking closer at the company's long-term plans.
One thing that sticks out is the company's increasingly conservative financing strategy. In years past, the company paid out nearly all its cash flow to investors, which forced it to rely on the capital markets and other means to finance expansion projects. Going forward, though, Energy Transfer plans to pay out a much lower percentage of its cash flow, which will enable it to cover its dividend by a more conservative 1.7 to 1.9 times. In doing so, the company estimates that it will generate $2.5 billion to $3 billion in excess cash per year, which it can use to fund about 50% of its planned expansion spending in 2019. That strategy lines up with Enterprise Products Partners' conservative plan, which is also aiming to finance half of its anticipated capital spending with retained cash going forward.
Internally funding the bulk of its growing slate of expansion projects is important because it will enable the company to grow earnings and cash flow on a per-unit basis, which will enhance the long-term sustainability of the dividend. That growth could eventually allow the company to start increasing its payout once again.
Verdict: Safe and secure
Energy Transfer has all the characteristics of a solid dividend stock since most of its cash flow comes from stable sources while its financial metrics are at conservative levels. On top of that, the company expects to generate significant excess cash in the coming years, which should provide it with most of the funds needed for its large backlog of expansion projects that should boost its cash flow further in the future. Because of those factors, Energy Transfer's 8%-yielding dividend looks safe for the long haul.
