Energy Transfer (ET 1.41%) has been a chronic underperformer. Units of the master limited partnership (MLP) have declined another 2% this year, and are now roughly 60% off their all-time high, which they hit right around the time oil prices lost their grip on $100 a barrel about five years ago. Even after adding in its dividend, the company's total return over the last five years is a negative 33%.
However, that lackluster performance in the past doesn't necessarily mean Energy Transfer will continue lagging in the future. Here's the case for and against buying this badly beaten-down energy company.
The bull case for Energy Transfer
While Energy Transfer's unit price has continued to slide over the past several years, its earnings have grown at an impressive 18% compound annual rate since 2015 thanks to its expansion program, and its valuation has gotten progressively cheaper. The company is currently on track to generate $11 billion of adjusted EBITDA this year. With its enterprise value (EV) falling to about $90 billion, it trades at just around eight times its EV to EBTIDA. That's an extremely low valuation, as most of its peers trade at more than 10 times EB/EBITDA.
One factor that has weighed on the company in recent years is the amount of debt on its balance sheet. However, Energy Transfer has made several moves to shore up its financial profile. Its debt-to-EBITDA ratio is on track to be within it target range of 4.0 to 4.5 next year. Meanwhile, the company's growing income stream has helped drive a significant improvement in its distribution coverage ratio. As a result, it's currently covering its nearly 10%-yielding payout by a comfortable 1.98 times. Its high-yielding payout is on a much sturdier foundation.
Energy Transfer also still has lots of growth up ahead. The company recently bought SemGroup for $5 billion, which will provide an immediate boost to its EBITDA and cash flow per unit. Furthermore, the deal enhanced its future growth prospects by adding a new pipeline project. Overall, the company expects to spend about $4 billion on expansion projects this year, and it has roughly $5.2 billion of additional ones in the backlog to drive growth over the next couple of years.
The bear case for Energy Transfer
Aside from its balance sheet, one factor that seems to be weighing on Energy Transfer's valuation is its MLP structure. Investors have become increasingly less fond of this entity in recent years because of the added tax burden of their Schedule K-1 forms. Several energy companies have since acquired their MLPs, while others have converted into corporations. Even leading MLP Enterprise Products Partners recently admitted that it might need to abandon this structure if it continues weighing on its valuation.
A longer-term concern with Energy Transfer is the accelerated adoption of renewable energy. Thanks to rapidly declining costs, especially for energy storage, it's becoming much cheaper to build new wind and solar energy generating facilities that can provide steady power. As that happens, it will reduce the need for developing new natural gas power plans to supplement renewables, which could affect demand for natural gas and the ability of pipeline stocks to expand.
Verdict: Energy Transfer is a buy
While there are some longer-term headwinds that investors need to monitor, Energy Transfer trades at a ridiculously low value these days, especially in light of its improving balance sheet and solid growth prospects. It has enormous upside potential. Add that to its well-supported high-yielding payout, and it's an excellent stock to consider buying these days.