Check out the latest Energy Transfer earnings call transcript.
Companies that pay a dividend have historically beat the market, delivering an average annual total return of 9.25% compared to 7.7% for the S&P 500, according to data by Ned Davis Research. However, the main driver of the outperformance was companies that either initiated a dividend or increased it on a consistent basis. That's why investors shouldn't get caught up in a stock's current yield, but instead, focus on whether it can increase its payout.
One stock that's likely on the radar of income investors is midstream giant Energy Transfer (ET 1.57%), as it currently yields an eye-catching 8.3%. Here's a look at whether the company could boost its already high-yielding dividend in 2019.
Drilling down into the numbers
Energy Transfer has gone to great lengths to firm up its financial foundation over the past few years so that it's in a better position to support its high-yielding payout and grow its operations. The company has consolidated several of its publicly traded affiliates to reduce costs and complexity. In addition to that, it sold assets and made a series of other moves to bolster its balance sheet. As a result of these efforts, Energy Transfer enters 2019 in its strongest position in years.
The company has a healthy balance sheet, backed by its lowest leverage ratio in quite some time. Consequently, it was recently able to issue $4 billion of low-cost debt, which it intends on using to pay off higher-cost borrowings. Furthermore, Energy Transfer expects to generate enough cash in 2019 to cover its high-yielding payout by a comfortable 1.7 to 1.9 times. That will leave it with $2.5 billion to $3 billion in excess cash to help finance expansion projects, which would cover more than half of its planned capital spending this year. Meanwhile, with its stronger balance sheet, the company can cover the remaining amount with incremental debt. Because of its stronger financial profile, Energy Transfer's high-yielding payout is on solid ground.
Considering the dividend growth prospects
Energy Transfer has a checkered past when it comes to increasing its distribution to investors. While the company gave them two raises in 2017, it maintained its payout level last year. And before restarting distribution growth at the end of 2017, the company went eight straight quarters without an increase. That has been a pattern with Energy Transfer over the years as it has gone through long droughts where it didn't give its investors a raise.
On the one hand, there's reason to be optimistic that the current streak of quarters without an increase could soon come to an end since the company's financial profile is back on solid ground thanks to last year's efforts. Not only does Energy Transfer cover its current distribution with plenty of room to spare, but it's on track to deliver significant earnings growth this year. While the final numbers aren't in, it was on pace to produce more than $9 billion in earnings for 2018. Meanwhile, after completing several expansions last year, with a few more scheduled to enter service this year, Energy Transfer is on track to earn $10.6 billion to $10.8 billion in 2019. As a result, the company has the growing income stream necessary to support a dividend increase in 2019.
However, Energy Transfer's management team noted on the company's third-quarter conference call that it's not yet ready to resume distribution increases. First of all, the company wants to ensure it has the funding needed to build its current slate of expansion projects before sending more cash to investors. In addition to that, it wants to see its leverage ratio fall even further, which would put it in position for a credit rating upgrade. Once that happens, the company has two options for its growing stream of cash flow: restart distribution growth or start buying back some of its units, which are dirt cheap after tumbling last year when the market sold off.
A dividend increase is still up in the air
While Energy Transfer's financial profile has improved significantly over the past year, the company isn't yet at its target level. Furthermore, even when it achieves that goal, boosting the dividend might not be its best use of cash since it's trading at such a low valuation that it could use the money to buy back its beaten-down units. In light of all that, investors shouldn't bank on Energy Transfer giving them a raise this year.