Businesses go through good periods and bad periods, which is just a fact of life on Wall Street. What happens in the weak periods is telling, but for more aggressive investors, the results achieved during the good times will likely be the main focus. So there are reasons why conservative investors will want to avoid Energy Transfer (ET 0.65%) and investors willing to take some risk might want to buy it.
The problem with management
Starting with the negatives, Energy Transfer made a business decision in 2016 that looked very much like the midstream master limited partnership (MLP) was putting its CEO's financial safety above that of its unit holders. It is a long and sordid story, but the quick version is enough to get a feel for the problem.
Image source: Getty Images.
Energy Transfer inked a deal to buy Williams Companies. The energy market hit a rough patch, and getting the deal that Energy Transfer initiated would have required cutting the distribution, taking on debt, selling dilutive units, or some combination of these things. All would have been negative events.
Energy Transfer worked to scuttle the deal. Its efforts included selling convertibles. The founder and CEO at the time (now the chairman of the board) was a big purchaser of the convertible, which would have effectively protected the income he generated from Energy Transfer if there were a dividend cut, leaving most other unitholders to take the hit. While this is a simplification of a very complex issue, you can see where conservative investors might have trust issues here.
Given that trust is one of the most important aspects of investing, the roughly 10% distribution yield here just isn't worth it. You can buy peer Enterprise Products Partners (EPD 0.43%) and collect a 7.5% yield without the baggage. Also of note, Energy Transfer cut its distribution in 2020 (more on this below), while Enterprise has increased its distribution annually for nearly a quarter of a century.
What's to like?
The distribution cut in 2020 came as the energy industry witnessed a demand drop because of the economic closures used to slow the spread of the coronavirus. The decision was reasonable, given the circumstances. That said, Energy Transfer has increased the distribution six times, pushing it above the level it was at prior to the cut. It looks like there is a focus on ensuring unitholders are rewarded for sticking around. In the first quarter, the distributable cash flow was roughly twice the total distributions paid, suggesting there's ample room for adversity before a cut would be a risk again.
Meanwhile, the partnership reported a number of volume records across its pipeline systems in the first quarter of 2023. After the end of the quarter, it completed its acquisition of Lotus Midstream, leading to an increase in its full-year guidance for adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). The business seems to be doing fairly well.
Energy Transfer is a large and widely diversified industry player, with operations in natural gas, oil, refined products, and liquefied natural gas. The midstream sector is in a state of flux as the world shifts toward cleaner energy sources, but carbon fuels remain vital to the world economy. The result is that ground-up capital investment may not be a huge opportunity.
Consolidation could be, however, highlighting the recent deal between Oneok and Magellan Midstream. Although the Williams fiasco suggests a checkered past here, the Lotus deal shows Energy Transfer can get deals done. And with such a broad portfolio, it has many different sector niches to consider.
Regaining trust
At the end of the day, conservative investors, perhaps most investors, should still err on the side of caution here, given that a peer like Enterprise Products Partners offers a very generous yield and a more unitholder-friendly business history. But for more aggressive types looking to maximize the income they generate, Energy Transfer might still be of interest. A roughly 10% yield from a midstream MLP that appears to be performing fairly well today while rewarding investors with distribution increases could indeed be hard to ignore for some investors.
