I have a simple investment strategy. I primarily make investments that generate income, which I use to buy more income-producing investments. My plan is to steadily grow my passive income streams so that they can eventually cover my expenses.
My main focus is investing in companies that pay attractive income streams that will likely steadily rise. One company that has delivered a massive dose of both over the past year is Energy Transfer (ET 0.05%). The master limited partnership (MLP) offers a 9.7%-yielding distribution following a 75% increase over the past year. While I don't think the energy company can grow its payout that fast in the future, I do expect it to keep rising. That's why I couldn't resist adding to my position earlier this month.
NYSE: ET
Key Data Points
The massive payout is on a sustainable footing
Energy Transfer has had its ups and downs over the years. The MLP had to slash its distribution by 50% in 2020 due to the pandemic's impact on its operations and financial situation. That enabled it to retain more cash for debt reduction. Along with earnings growth, the debt reduction has helped drive Energy Transfer's leverage ratio down to within its targeted range of 4 to 4.5 times debt-to-EBITDA.
The company now has more financial flexibility with its balance sheet back on a firmer footing. That enabled it to steadily bring its distribution back up to its former peak.
Even at a much higher level, Energy Transfer generates plenty of cash to cover its distribution. During the fourth quarter, the MLP produced $1.9 billion of cash while distributing $945 million to investors. It retained more than enough cash to cover capital expenses, which averaged less than $500 million per quarter (total capex was $1.93 billion last year). That gave it additional financial flexibility for debt reduction. Meanwhile, capital spending will come down this year to $1.6 billion-$1.8 billion, allowing it to maintain lots of financial flexibility.
Refueling the growth engine
Energy Transfer recently used some of its financial flexibility to make an acquisition. It's buying Lotus Midstream for $1.45 billion. It's paying $900 million in cash and issuing 44.5 million of its common units to the seller. That deal structure makes the transaction leverage neutral, preserving the MLP's financial flexibility. Meanwhile, Energy Transfer expects that the deal will be accretive to its distributable cash flow on a per-unit basis. It also expects that it will boost its free cash flow. Because of that, the deal will enhance its financial profile, putting it in an even stronger position to sustain and grow its monster distribution.
By improving upon its already solid financial profile, Energy Transfer has even more flexibility to make additional grow-related investments as opportunities arise. It's pursuing several organic expansion projects to fuel growth in the coming years.
For example, it recently signed a letter of intent with Occidental Petroleum. The oil company is working to develop the Magnolia Hub, a potential carbon capture and sequestration solution for industrial emitters in the Lake Charles, Louisiana area. The companies are working to secure customers for the project. Energy Transfer would build a pipeline to transport captured carbon dioxide to the sequestration site that Occidental Petroleum would build and operate.
Meanwhile, Energy Transfer has been working to secure commercial contracts and investors to convert its Lake Charles LNG site from imports to exports. It's also working on a potential petrochemical project. While both projects have experienced some delays, the company hopes they'll move forward eventually. Securing projects like these would help grow its cash flows in the future.
In addition to organic growth, the company can continue to make acquisitions. Energy Transfer has a long history of being a consolidator in the midstream sector, with Lotus Midstream the latest example. Like that deal, future transactions could boost its free cash flow, giving it more money to pay distributions and invest in expansion.
A massive payout with upside potential
Energy Transfer checks all the boxes for me. The MLP has an attractive payout supported by a solid financial profile. It has the flexibility and growth prospects to continue expanding its operations and grow its cash flow. Because of that, the company should be able to increase its distribution in the future. That income with upside potential is why I'll likely keep adding to my position in Energy Transfer as I have more cash to invest.
