Energy Transfer's (ET 0.44%) huge 9.7% distribution yield will probably be very attractive to dividend-focused investors. But if you take the time to get to know the master limited partnership (MLP), you'll find that it comes with more risk than you might think. Here's some important facts that should turn conservative investors away from Energy Transfer.
First the good stuff
It is hard to complain about a 9.7% distribution yield, which is way more than you would get from an S&P 500 Index ETF (1.6%) or the average energy stock (4%), using Vanguard Energy Index ETF as a proxy. So it's understandable that investors looking to maximize their current income might be drawn to Energy Transfer.
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Then there's the fact that the distribution has been increased for five consecutive quarters. That suggests that the business is getting stronger, not weaker. And Energy Transfer has a large collection of fee-based assets that should provide a strong underpinning to the MLP's distribution. On that note, Energy Transfer's distributable cash flow covered its distribution by roughly two times in the fourth quarter of 2022.
All in, from a cursory look, Energy Transfer seems like a fairly attractive investment choice. The problem comes when you dig in a little bit.
When hard times hit
Here's the thing: The energy sector went into a tailspin in 2020 because of declining demand related to the economic shutdowns used to slow the spread of the coronavirus. Energy Transfer reacted by cutting its distribution in half. Yes, that move helped to ensure the partnership had ample cash flow should it need it. However, many peers, such as Enterprise Products Partners (EPD -0.41%), supported their distributions through this difficult period. In other words, if you're looking for a reliable income stream, you might be better off elsewhere. Note that Enterprise has increased its distribution annually for 24 consecutive years, so 2020 wasn't a fluke.
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And then there's the issue of The Williams Companies. While it was a long time ago now, an Energy Transfer entity agreed to buy The Williams Companies in 2015. The energy sector, however, began to struggle and 2016 was a very difficult year. Energy Transfer got cold feet and tried to scuttle the deal, because going through with it would have necessitated a huge increase in leverage and, perhaps, even a dividend cut. In some ways, killing the merger was the right call.
Although my colleague Matthew DiLallo provides a deeper dive into the sordid story, a quick overview should be enough to get the point across. Energy Transfer sold convertibles in a private placement as it fought to scuttle the deal. A large chunk of that sale went to the company's CEO and would have, effectively, protected the CEO from the risk of a dividend cut. That feels as if the company was protecting insiders at the expense of shareholders and should probably lead to trust questions. The CEO at the time is now the chairman of the board, so he's still, arguably, in a position of control.
There are other options
Energy Transfer has a huge yield today and the distribution has been growing of late, bringing it back to its pre-cut level. However, if you are looking for reliable income, there are midstream peers with better track records, like Enterprise Products Partners. The real deal-killer, though, is the convertible issue that helped to sink Energy Transfer's Williams Company acquisition, as it looked like a move to protect the CEO at the expense of shareholders. If a distribution cut isn't enough of a trust issue, the convertible should easily tip the scale to the negative side. A huge yield isn't enough to make up for the potential risks that decision brings up.
