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Is Energy Transfer a Buy?

By Matthew DiLallo - Jul 25, 2019 at 7:32PM

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The midstream giant has a lot to offer investors these days.

Master limited partnership Energy Transfer ( ET 1.79% ) is having a great year in 2019. The midstream company got off to an excellent start during the first quarter, generating record results as earnings and cash flow soared nearly 40%. That strong start has helped push up the value of the MLP's units more than 13% so far this year.

That big gain over the last few months might have some investors wondering if the company is still worth buying. Here's a closer look at the bull and bear cases for Energy Transfer.

A pipeline in a green field, heading towards the mountains

Image source: Getty Images.

The bull case for Energy Transfer

The main draw of Energy Transfer is its high-yielding distribution, which is currently around 8.2%. The company supports that well-above-average payout with stable cash flow, given its expectation that fee-based contracts will supply 85% to 90% of its annual earnings. Meanwhile, Energy Transfer only pays out about half of its cash flow to support its payout. Those sound financial metrics suggest that the company's current distribution level should be sustainable over the long term.

The midstream company adds to its appeal by also boasting above-average growth prospects. Despite already being one of the largest companies in its sector, Energy Transfer is growing fast. The MLP currently expects to produce between $10.6 billion and $10.8 billion of adjusted EBITDA this year, which at the midpoint would be 12.5% above 2018's level. That fast-paced growth is nothing new, as Energy Transfer has increased its adjusted EBITDA at a 17% compound annual rate since 2015. Meanwhile, it has plenty more growth ahead, given its plan to spend $5 billion on expansion projects this year.

Despite its rock-solid income stream and growth prospects, Energy Transfer trades at a rock-bottom valuation. With the company's current enterprise value at $95.6 billion, it trades at just 8.9 times this year's projected adjusted EBITDA. For comparison, that's well below its peer-group average, which is an enterprise-value-to-EBITDA ratio of about 11.5.

The bear case for Energy Transfer

If there's one knock against Energy Transfer, it's that the MLP has a weaker balance sheet. The company has borrowed lots of money to grow over the years, which pushed its leverage ratio up to an elevated level. During the first quarter, for example, debt-to-EBITDA was around 4.7, above its target range of 4.0 to 4.5. The MLP is working to get leverage down to its ideal level by growing its earnings and selling assets. The company currently believes it can achieve that goal by year-end.

Energy Transfer also had trouble completing some of its largest expansion projects on time due to opposition and construction issues. The Bakken Pipeline system, for example, started up six months late because of a permitting problem. Meanwhile, the company experienced several construction missteps while building the Rover and Mariner East 2 pipelines. Those delays cost the company money and damaged its credibility. This checkered past could cause customers to sign on to rival projects, which might harm its longer-term growth prospects.

Verdict: Energy Transfer is a buy

While Energy Transfer's weaker balance sheet and pipeline construction issues are a concern, it more than offsets those risks with its high-yielding payout, growth potential, and low valuation. That's why the pipeline company looks like an excellent buy these days, even if it's not quite as cheap as it was earlier in the year.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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