Energy Transfer (ET -0.19%) has a spotting track record of growing value for its investors. The master limited partnership (MLP) had overextended itself in the past, forcing it to slash its distribution to investors in 2020 to conserve cash. That allowed the midstream giant to shore up its financial profile by internally funding expansion projects and reducing leverage.
That plan has worked to perfection. The MLP has achieved its leverage target, enabling it to return the distribution to its former peak with more growth ahead. The company now yields an eye-popping 10%. That's too attractive to pass up, which is why I've been buying units of the MLP hand over fist recently.
The big-time payout is on rock-solid ground
Energy Transfer's diversified midstream platform generates lots of relatively stable cash flow. About 90% of its earnings come from fee-based contracts, giving it a very solid foundation of steady cash. The MLP produced slightly more than $2 billion of distributable cash flow during the first quarter.
After paying distributions, the company had $965 million in excess cash. That was more than enough to cover the company's capital spending, including $407 million of growth-related investments.
Energy Transfer used its remaining cash to further strengthen its balance sheet. That has it on track to achieve a leverage ratio at the lower end of its 4.0-4.5 times target.
With a business that generates stable cash flow, a conservative payout ratio, and a strong balance sheet, Energy Transfer's high-yielding distribution is on a very firm foundation.
The big-time payout is heading even higher
Energy Transfer's focus over the past year has been on shoring up its financial foundation so that it could return its distribution to its pre-pandemic peak. With both goals accomplished, the MLP recently set its sights higher. It established a new target of growing its distribution by 3% to 5% per year. The MLP intends to increase the payout by $0.0025 per unit each quarter.
The company already has the financial flexibility to achieve that goal thanks to its relatively low distribution payout ratio of around 50%. However, increasing the payout ratio isn't the main factor fueling distribution growth. It has two power sources: organic expansion projects and acquisitions.
The MLP expects to invest about $2 billion in growth projects this year. That's slightly more than last year and above its initial budget range of $1.6 billion-$1.8 billion after the company recently approved a few more new projects. It has several more expansion projects under development, including a potentially long-term needle-mover that recently encountered a major roadblock.
Acquisitions are another major growth catalyst for Energy Transfer. The company recently closed its $1.45 billion deal for Lotus Midstream. It structured that transaction so that it would be leverage neutral. Meanwhile, the deal will be accretive to the MLP's distributable and free cash flow. That means it will supply the pipeline company with some incremental fuel to grow the distribution in the near term.
That deal won't be its last. Energy Transfer is a consolidator in the midstream sector. It's always looking for deals that will enhance its midstream network while being accretive to its financial metrics. Given its low leverage ratio, the company has ample financial flexibility to continue making acquisitions as accretive opportunities emerge.
A very compelling passive income producer
Energy Transfer's investors have endured their share of pain over the years, including a deep distribution cut in the pandemic's aftermath. However, that pain enabled the company now to enjoy the gain of a much stronger financial profile, meaning it was able to return the payout to its former peak and plans to steadily increase it in the future. I want more of that big-time and growing distribution in my portfolio, which is why I'm buying units of the MLP hand over fist these days.
