Energy Transfer (NYSE:ET) has been in a bit of a tight spot financially over the past few years. The master limited partnership has been trying to fund a multibillion-dollar expansion program at the same time it's paying an 8.8%-yielding cash distribution to its investors. Making matters worse is that the company had lots of debt on its balance sheet, which limits its flexibility. Because of these factors, the company has had to walk quite a tightrope to accomplish all its goals.
While the midstream giant still has some work to do, it's getting close to an inflection point and will have much more financial flexibility next year. Here's why investors should be excited about what could be coming their way in 2020.
Getting through another heavy year
Energy Transfer is still in the middle of a major spending spree to expand its midstream infrastructure and expects to invest between $4.6 billion and $4.8 billion on growth projects this year. While it generates lots of free cash flow, it expects to have only between $2.5 billion and $3 billion in excess cash after paying its distribution to investors. That leaves it with a large gap to fill.
Typically, midstream companies finance expansions with a 50-50 blend of debt and equity. However, Energy Transfer's leverage ratio is currently above its 4.0 to 4.5 target range, which means it needs to be creative in balancing its budget. Among the moves it made was selling assets, issuing preferred stock, and forming joint ventures to help finance expansion projects.
Thanks to these moves, Energy Transfer has been able to fund its distribution as well as capital projects. Because of that, as its earnings grow, its leverage ratio will trend toward its target range in the next year. That sets the company up to have much more financial flexibility in 2020.
More capacity to reward investors in 2020
In addition to having more balance sheet flexibility, the company's capital spending could be lower. While Energy Transfer hasn't put out its 2020 budget yet, the company did provide a glimpse of what it might look like on the second-quarter conference call. CFO Tom Long said that "our capex spend is probably in that $3 billion to $4 billion range" over the long term. On the one hand, he made it clear that this doesn't necessarily apply to 2020 since it's still working on what projects it will add to its backlog. However, spending will probably fall next year, since the company has several large-scale projects on track to start up by the end of 2019.
That suggests Energy Transfer will produce more free cash flow next year. That will potentially give it additional money to return to investors. It has two ways to do that: increase the distribution and repurchase units.
The pipeline giant has made it clear that its goal is to grow the distribution over the long-term. However, given how cheap its units trade these days, a buyback would also make sense.
Energy Transfer has stated that those options aren't mutually exclusive. As such, it could give investors a small distribution increase next year while also approving a unit repurchase program. That's the approach taken by both Kinder Morgan (NYSE:KMI) and Enterprise Products Partners (NYSE:EPD). Those pipeline giants both approved $2 billion repurchase programs that they've been using opportunistically over the past year. Kinder Morgan has already repurchased $525 million of its shares while Enterprise Products Partners spent $81 million to buy back some of its units. Meanwhile, they have also increased their high-yield payouts. Depending on market conditions, Energy Transfer could go a similar route next year.
Nearing an inflection point
Energy Transfer will spend the rest of this year walking a tightrope. That's because it's still funding a large slate of expansion projects while also paying a well above average distribution to investors. However, its financial flexibility should significantly improve next year as those expansions pay dividends. Because of that, Energy Transfer should be in the position to boost its distribution as well as start buying back its dirt cheap units. That sets investors up for what could be a big year.