Pipeline behemoth Energy Transfer (ET) is having a record year. The company's cash flow catapulted nearly 40% during the first quarter, fueled by the recent completion of several needle-moving expansion projects. Overall, the midstream giant hauled in almost $1.7 billion of cash during the period, which was enough money to cover its monster 8.6%-yielding dividend with $856 million to spare. That gave the company even more money to invest in expansion projects.
Despite those exceptional results, shares of Energy Transfer are down about 17% in the past year. As a result of that underperformance, the pipeline company's stock remains ridiculously cheap, especially considering all the growth it still has coming down the, er, pipeline.
A bottom-of-the-barrel valuation
Energy Transfer anticipates that it will generate $10.7 billion of adjusted EBITDA this year, which would be about 12.5% above last year's level. With the midstream company's enterprise value (EV) currently at $93.5 billion, it implies that the company trades at just 8.7 times earnings. That's by far the lowest valuation in its peer group.
The next-cheapest rival, Kinder Morgan (KMI -0.92%), for example, trades at 10.7 times its EV/EBITDA. That higher valuation comes even though Kinder Morgan only expects to grow its EBITDA by 4% this year. Meanwhile, the most expensive peer, ONEOK (OKE -0.22%), sells for a gaudy EV/EBITDA multiple of 14.5 times. That pricey valuation comes even though ONEOK is only on track to increase its EBITDA by about 6% this year.
The main issue that seems to be weighing on Energy Transfer is its elevated leverage. The company currently has a debt-to-EBITDA ratio of around 4.7 times, which is above its 4.0 to 4.5 times target range. Further, this metric is higher than those of both Kinder Morgan (~4.5 times) and ONEOK (~4.0 times). However, Energy Transfer is working on getting that number down to its target range. Not only is its EBITDA expanding at a fast pace, but it's making other moves to reduce its debt level. As leverage continues coming down, that should help relieve the pressure holding down Energy Transfer's valuation.
A fully fueled growth engine
In addition to the upside as Energy Transfer's valuation moves up closer toward its peers, the company has more growth ahead of it that should drive continued fast-paced earnings expansion. The company currently expects to invest $5 billion in growth projects this year. For example, it's expanding its Permian Express 4 pipeline as well as building the Arrowhead III natural gas processing plant, which should both start up during the fourth quarter. Meanwhile, it expects to finish the Mariner East 2X natural gas liquids pipeline as well as the J.C. Nolan diesel pipeline by year-end. While these projects will provide it with some incremental income this year, the uptick will be even more noticeable in 2020.
Speaking of next year, Energy Transfer has several major projects currently under construction that will help drive additional earnings growth. The company's Lone Star Frac VII project, for example, should start up in the first quarter of 2020. Meanwhile, the Lone Star Express pipeline expansion and its Orbit Ethane Export Terminal should come online by the end of next year.
On top of that, the company has several other growth projects in development. Energy Transfer is working on another expansion of its Bakken Pipeline that could be in service by late 2020. Meanwhile, it's looking at a variety of options to expand its oil pipeline capacity in the Permian Basin. Finally, it's working with energy giant Shell to develop a large-scale LNG export project along the U.S. Gulf Coast.
As the company completes these and other projects, they'll help it continue growing its earnings and cash flow at a fast pace. That earnings growth should help drive Energy Transfer's share price higher in the coming years. Not only will it give the company more money to invest in expansion projects, but Energy Transfer could use some of the funds to increase its high-yielding distribution or repurchase some of its dirt-cheap stock.
Get paid well while you wait for the upside to materialize
Energy Transfer trades at an absurdly cheap valuation these days because the market isn't giving it credit for its growth prospects or the improvements to its balance sheet. Because of that, shares could have significant upside as its valuation improves and it continues growing earnings. In the meantime, however, investors can collect its generous income stream while they wait for the market to reward Energy Transfer for all the work it has done to improve its financial profile and growth prospects.