Energy Transfer's (ET -1.44%) performance this year has been a real head-scratcher. The energy-focused master limited partnership (MLP) is on track to generate record earnings, which it anticipates will be 16% above last year's total. That's a much faster pace than its initial view that they would increase by about 12.6% year over year. It's an impressive feat considering all the volatility in oil and gas prices this year.
However, despite that strong year financially, units of the MLP have tumbled 12% on the year, leaving it to now trade at an insanely cheap valuation. Meanwhile, its value proposition has gotten even better after the company closed its needle-moving acquisition of SemGroup this week. The impact of that deal makes its 10.5%-yielding distribution an even more enticing option for income-seeking investors.
The payout was already on solid ground
More often than not, a double-digit yield implies extreme risk. However, that is not the case with Energy Transfer's payout. Before closing the SemGroup deal, the company was generating enough cash to cover its sky-high payout by nearly two times. For comparison's sake, most MLPs target distribution coverage of at least 1.2. With such a strong coverage level, the company has been able to retain nearly $2.5 billion of cash to help finance growth projects.
While it has spent roughly $3.1 billion on expansions this year, most midstream companies typically borrow up to 50% of a project's cost. Because it hasn't come anywhere near that level, its leverage ratio has come down thanks to its fast-growing earnings.
As a result, its leverage ratio is currently on track to be within its target range of 4.0 to 4.5 times debt-to-EBITDA next year. That would be a significant improvement from prior years, as leverage was above 5.5 at the end of 2016.
A sensible addition
Thanks to its much stronger financial profile, Energy Transfer was able to swoop in and acquire SemGroup at an attractive price of nine times EBITDA. The deal therefore will immediately bolster its cash flow per share, thus enhancing distribution coverage. Furthermore, it won't negatively affect its balance sheet metrics.
In addition to that financial boost, the deal is also highly strategic. The highlight is the acquisition of SemGroup's Houston Fuel Oil Terminal (HFOTCO), which strengthens the company's crude oil transportation, terminalling, and export capabilities by giving it a strategic position on the key Houston Ship Channel. Energy Transfer plans to build a pipeline from HFOTCO to its existing Nederland terminal so that it can provide even more market options to its customers. That could help facilitate other expansions in the future, such as its proposal to nearly double the capacity of its Bakken Pipeline System, which flows into Nederland.
Meanwhile, SemGroup also expands Energy Transfer's oil and natural gas liquids infrastructure footprint in the key production basins of Colorado and Oklahoma while also giving it a presence in Canada. Most of these assets generate stable cash flow backed by long-term contracts. As such, the deal will increase its diversification while also further reducing its direct exposure to commodity prices.
Get paid quite well while waiting
For whatever reason, the market isn't giving Energy Transfer any credit for its strong year, which includes its needle-moving acquisition of SemGroup. That purchase checks all the boxes as it will boost cash flow per share and enhance its operations without harming its balance sheet.
At some point, the market will realize it made a mistake by pushing down Energy Transfer's valuation to a bottom-of-the-barrel level. In the meantime, however, income-seekers can buy into an even more attractive investment opportunity since Energy Transfer's 10.5%-yielding distribution is now on an even stronger foundation.