Energy Transfer (ET -0.19%) is coming off a head-scratching year. The energy-focused master limited partnership (MLP) delivered excellent results across the board. Earnings are on track to rise 16%, its balance sheet has improved, and it enhanced its growth prospects via a needle-moving acquisition.
But despite all these positives, units of the MLP declined by about 3% in 2019. That vastly underperformed crude prices and the S&P 500, which both rocketed roughly 30% on the year.
That lackluster performance, however, makes Energy Transfer one of the most compelling income-focused investment opportunities for 2020, in my opinion. Here's why I think it could produce big-time total returns for yield-seeking investors this year.
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A monster yield backed by a rock-solid financial profile
The main attraction at Energy Transfer is its monster 9.5% yield. While a payout approaching the double digits is usually a sign of trouble, that's not the case with Energy Transfer. That's because the midstream giant had generated enough cash through the third quarter to cover its distribution by a very comfortable 1.98 times, which is above its 1.7 to 1.9 long-term target range. As a result, the company produced $2.4 billion in excess cash that it was able to use to fund expansion projects.
Adding to the sustainability of Energy Transfer's payout is its very stable cash flow. Overall, fee-based contracts and other predictable sources supply about 85% of its annual earnings. The company further backs its distribution with an investment-grade credit rating. While its leverage ratio is currently a bit above its target range of 4.0 to 4.5 times debt to EBITDA, it's on track to decline into its targeted area in 2020 as its earnings keep growing. As a result, Energy Transfer's payout enters 2020 on a firm foundation.
Fast-paced growth for a deep-value price
Another appealing feature with Energy Transfer is its valuation. The slide in the company's unit price in recent years has pushed it down to an absurdly low level of about eight times its EBITDA. For comparison's sake, most of its peers sell for more than 10 times their earnings. Because of that, the company has lots of valuation upside.
That dirt cheap price doesn't make sense, especially when factoring in its compelling growth prospects. Energy Transfer invested about $4 billion into expansion projects last year and expects to spend another $3.6 billion to $3.8 billion on growth in 2020. On top of that, it paid $5 billion to buy SemGroup. That combination of organic and acquired growth should enable the company to increase its earnings at a double-digit rate again in 2020.
Meanwhile, it has plenty of fuel to keep growing beyond this year since it has another $1.5 billion of approved growth projects in its backlog that will start coming on line in 2021. Furthermore, it has several other expansions in development, including a major capacity increase for its Bakken Pipeline, an LNG export facility along the Gulf Coast, and an expansion in an oil export terminal.
Two potential 2020 catalysts that could further enhance returns
In addition to Energy Transfer's compelling combination of yield, value, and growth, the company has two other potential catalysts that enhance its upside potential. First, since it's on track to reach its targeted leverage level this year, the company will have more flexibility to use its excess cash. Instead of pouring it all into expansion projects, it could allocate a portion of it to start increasing its already eye-popping distribution or repurchase some of its dirt cheap units. If the company begins returning more cash to investors, that could help boost the valuation.
Another potential catalyst is that Energy Transfer could join several of its peers and convert into a corporation. That would broaden its appeal to more investors, which could boost its value since pipeline corporations currently trade at a premium compared with their MLP peers. As such, a similar move could help narrow Energy Transfer's valuation gap.
Plenty of fuel to produce big-time total returns
With a yield approaching double digits, Energy Transfer offers income-seeking investors a big-time income stream. But that's only part of the appeal. The MLP also trades at a ridiculously low valuation even though it's growing earnings at a double-digit rate. Add all that to some potential catalysts on the horizon, and Energy Transfer looks like it could produce significant total returns in 2020. That makes it stand out as the top stock for yield seekers to buy this year.
