Energy Transfer (ET 0.12%) recently increased its distribution by 15%, pushing its yield to an attractive 6.7%. The master limited partnership (MLP) said that this was the first step toward its ultimate goal of returning its payout to its former level. The energy company took another step toward achieving that target this week after agreeing to sell its interest in its Canadian operations. The deal will help strengthen its balance sheet and finance its U.S. expansion, potentially freeing up cash flow for further dividend increases.
Here's a look at what this deal means for Energy Transfer's big-time distribution.
Bidding adieu to Canada
Energy Transfer has agreed to sell its 51% interest in Energy Transfer Canada to a joint venture between Pembina Pipeline (PBA 0.31%) and funds managed by alternative asset manager KKR (KKR 0.71%). The deal values the Canadian midstream company at 1.6 billion Canadian dollars ($1.3 billion), including debt and preferred equity. Energy Transfer expects to receive about CA$340 million ($270 million) in cash proceeds when the deal closes in the third quarter.
Energy Transfer Canada is one of the largest gas processors in Alberta. It has six natural gas processing plants with a combined 1.29 billion cubic feet per day of processing capacity and 848 miles of natural gas gathering and transportation infrastructure. Energy Transfer acquired its interest in these Canadian operations when it purchased SemGroup at the end of 2019. However, the main draw of SemGroup was its Houston Fuel Oil Terminal, which strengthened Energy Transfer's crude oil business. That made the Canadian operations expendable. It was finally able to cash in on them this year, thanks partly to the energy markets' improving conditions.
The acquisition of a 51% interest in Energy Transfer Canada was part of a much larger deal between KKR and Pembina Pipeline. The two entities agreed to combine their western Canadian natural gas processing assets into a joint venture, including KKR's existing 49% interest in Energy Transfer Canada. The new joint venture, 60% owned by Pembina and 40% by KKR's global infrastructure funds, will collectively own CA$11.4 billion ($9 billion) of assets in Western Canada.
Image source: Getty Images.
Freeing up capital for other uses
The sale of its stake in Energy Transfer Canada will give Energy Transfer some cash to shore up its balance sheet and expand its U.S. operations. The midstream company has made significant progress in improving its financial situation over the past year. A big driver was its decision to reduce its distribution by 50% in 2020. That enabled it to retain more cash for debt reduction. As a result, the company cut its long-term debt by $6.3 billion last year. That got the MLP closer to its target of getting leverage between 4.0 and 4.5 times debt to earnings before interest, taxes, depreciation, and amortization (EBITDA).
Leverage should continue coming down this year. While Energy Transfer boosted its distribution by 15% and plans to increase its capital spending from $1.4 billion last year to between $1.6 billion and $1.9 billion this year, it should still generate several billion dollars of excess cash in 2022. Add in the roughly $270 million it will receive by selling its stake in Energy Transfer Canada, and it's another step closer toward achieving its leverage target. That would give it the flexibility to deliver on its dividend growth promise. The MLP can certainly afford that level, given that distribution coverage was nearly three times cash flow in the fourth quarter.
An increasingly attractive option for passive income seekers
Because Energy Transfer wants to return its distribution to its former level, the MLP could deliver explosive distribution growth in the coming quarters. The sale of its Canadian assets will put it in an even better position to achieve that goal by setting its balance sheet on a firmer foundation, freeing up its free cash flow for other uses. Add that upside potential to the MLP's already attractive yield, and it looks like an excellent option for investors seeking to generate passive income.
