Energy Transfer (ET 0.38%) is offering investors a generous 6.8% distribution yield. The midstream infrastructure company has a broadly diversified portfolio and just announced a 15% distribution hike to $0.175 per share per quarter, part of a plan to return the payment to its previous level of $0.305 per unit per quarter. That's another 70% of distribution growth, which will probably interest a lot of investors. But I just can't get myself interested in this name, and the recent conclusion of a long-running lawsuit helps explain why.
The business
Energy Transfer owns over 90,000 miles of pipelines. Roughly 95% of its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) is fee-based. About 25% of its EBITDA is tied to oil, 24% to natural gas liquids and refined products, 16% to interstate pipelines, 15% gets dubbed a generic "midstream", 8% intrastate pipelines, and 12% is from controlled entities including Sunoco LP and USA Compression Partners. All in, Energy Transfer's business is fairly diversified as far it goes in the midstream sector. In fact, it has some pretty interesting businesses, including Sunoco LP's specific focus on gasoline infrastructure.
Image source: Getty Images.
With a $32.5 billion market cap, meanwhile, Energy Transfer is one of the larger midstream names in the North American market. For reference, Kinder Morgan has a market cap of around $39 billion. Energy Transfer's debt to EBITDA ratio, which spiked to over eight not too long ago, has now gotten back down toward the low end of the sector at around 3.8. That's nearer to conservatively managed Enterprise Products Partners' 3.0 than Kinder Morgan's 5.4. And it suggests that Energy Transfer could probably be a consolidator in the midstream space, a role it has played in the past, noting the controlled master limited partnerships above.
Add in that distribution increase and the plans for more hikes, and there are a lot of things to like about this midstream name. But there are also things to worry about.
What's keeping me on the sidelines
For some, the first sign of trouble here will likely be the 50% distribution cut in 2020. That's not a bad reason to worry, though -- the pandemic's impact on demand in the broader energy sector likely had something to do with that. Ensuring that there was enough liquidity to survive in what was a very uncertain time is not a bad decision per se. And given the spike in the debt to EBITDA that year, you could easily suggest it was a good call to act quickly and decisively, even if it caused unitholders some near-term pain. The reduction in leverage and recent increase, and the promise of a return to the previous distribution level, are likely welcome relief.
ET Financial Debt to EBITDA (TTM) data by YCharts
So the distribution cut, while unfortunate, isn't something I would get too upset about. But a late 2021 court loss is a reason to be cautious. Energy Transfer was directed to pay Williams Companies (WMB 0.39%) a $410 million termination fee for a deal that was scuttled over five years ago. There's one big detail here that matters.
The basics are that Energy Transfer inked a deal to buy Williams Companies just before an unusually difficult time in the midstream sector. When the hard times hit, the deal no longer made sense for Energy Transfer, because consummating it would have required a massive increase in debt or a distribution cut (or even both). However, getting acquired at the agreed-on price would have been a good deal for Williams Companies, and it wanted to see the deal go through. There was an ugly back and forth, with Energy Transfer ultimately shutting the deal down based on tax complications. That's a simplification of a very complicated period, but it gets the job done.
The real problem in this is that, during this period, Energy Transfer issued convertible preferred shares, with the CEO of the partnership getting a significant amount of the issue. The convertible was structured in such a way that it would have sheltered CEO Kelcy Warren from the hit if Energy Transfer ended up having to complete the acquisition of Williams Companies and cut the distribution. I understand why the CEO did this, and it ended up helping to scuttle the deal -- but I'm pretty sure that, if I had been a unitholder, I would have been furious. It looks very much like the CEO protected himself at unitholders' expense. And it leaves a huge void in my mind in the trust department that Energy Transfer will probably never be able to fill, at least as long as Warren, who stepped away from that role but now holds the titles executive chairman and chairman of the board (along with being a major unitholder), is still around.
I have to have trust
In the end, I understand the 2020 distribution cut -- and, while unfortunate, it was probably a good call for Energy Transfer. That the partnership is increasing the distribution again with a target of returning it to previous levels is comforting.
But I don't understand why the partnership issued a separate share class that seemingly protected a prominent insider during the Williams Companies merger fiasco. I give my money to a company with the expectation that it will be used wisely and with my best interests in mind. The recent court loss over the scuttled Williams acquisition is a reminder that this isn't something I feel I can expect from Energy Transfer.
