Energy Transfer (ET -1.55%) set an ambitious goal. The energy master limited partnership (MLP) wants to return its distribution to its previous level, which is double where it started the year. The company recently took its first step in that direction, increasing the payout by 15% to push the yield up near 7%.
Here's a look at why the energy company believes it can deliver explosive income growth in the coming years.
Shoring up the foundation
Energy Transfer slashed its distribution by 50% in 2020 to retain more cash for debt reduction. As a result, the company generated $6.4 billion in excess cash flow after distributions in 2021. That enabled the MLP to reduce its long-term debt by $6.3 billion last year.
That debt reduction has relieved the pressure on Energy Transfer's balance sheet. The company is now closer to its target of getting its leverage ratio down to a range of 4.0 to 4.5 times debt to earnings before interest, taxes, depreciation, and amortization (EBITDA). The MLP is therefore comfortable returning more cash to investors, which led to the recent 15% raise.
Plenty of room to support a higher distribution
Energy Transfer plans to evaluate future increases to the distribution each quarter, with the ultimate goal to bring it back up to its previous level. The company will balance that aim with maintaining its leverage target, investing in growth opportunities, and opportunistically repurchasing its units.
What's clear from the company's financial results is that it's generating more than enough cash to support a higher distribution. The MLP recently reported its fourth-quarter results. During that period, it generated $1.6 billion in distributable cash flow. It also paid out $540 million in distributions, meaning it covered its distribution by nearly three times. So, if it doubled its payout, the MLP would still be able to cover it by a comfortable 1.5 times.
On the fourth-quarter conference call, Energy Transfer's CFO stated that returning to its prior distribution level is a "top priority." However, even though the company could afford to boost it to that level now, it's taking a more conservative approach. It wants to make sure it achieves its leverage ratio and has the financial flexibility to invest in attractive growth projects as they emerge.
The company has already started ramping growth spending. Energy Transfer plans to invest between $1.6 billion and $1.9 billion on expansion projects in 2022, up from $1.4 billion last year. In addition, it's evaluating a potential new pipeline in the Permian Basin to improve that region's takeaway capacity and is in ongoing discussions with Panama to study the feasibility of jointly developing natural gas liquids assets in the country. It also formed an alternative energy group to explore lower carbon investment opportunities such as carbon capture and storage and renewable fuels transportation.
The company needs to hold back on delivering more distribution growth in the near term to give it the flexibility to fund additional expansion opportunities. If Energy Transfer can secure more growth-related investments, it'll provide the MLP with more fuel to grow the distribution in the future. However, if they don't pan out, the MLP can accelerate distribution growth to achieve its goal sooner.
A monster yield if it achieves its target
Energy Transfer wants to return its distribution to its prior level. That means investors who buy today set themselves up for a payout that could approach a 12% yield in the future. While it could take the MLP some time to achieve its goal, it certainly has the cash flow to support that much higher payout level. That makes it an appealing option for investors seeking a potential gusher of passive income.