Energy Transfer (ET 0.12%) currently offers a 9.7%-yielding distribution. A big driver of the master limited partnership's (MLP) high yield is its deeply discounted valuation. It trades at more than 30% below the average Wall Street analysts' price target and over 80% less than it would if it fetched the median-trading multiple of its peers. Because of that, it offers investors the opportunity to earn significant passive income and potentially capture substantial unit-price appreciation.
Here's a closer look at the pipeline giant's value proposition.
A monster payout that should keep rising
Energy Transfer's main draw is its massive cash distribution. The MLP currently pays $0.3075 per unit each quarter, giving it a 9.7% yield at the recent price. While a payout approaching double digits is usually a warning sign, Energy Transfer's big-time payout is safer than it seems.
The midstream company generates very durable cash flows backed primarily by long-term contracts and government-regulated rate structures. It produced nearly $1.6 billion in distributable cash flow during the second quarter. That covered its massive payout with $579 million to spare. The company used that excess cash to fully finance growth-capital expenses ($387 million in Q2) and continue to strengthen its already solid investment-grade balance sheet. Energy Transfer expects its leverage ratio to be at the lower end of its 4.0 to 4.5 times target range.
Energy Transfer's stable cash flow should continue rising in the future. The MLP expects its growth to reaccelerate in the coming years fueled by a growing backlog of expansion opportunities. That drives its view that it can invest $2 billion to $3 billion per year on capital projects, up from $2 billion in recent years. Energy Transfer also continues to make value-enhancing acquisitions. It bought Lotus Midstream for nearly $1.5 billion earlier this year and recently agreed to acquire Crestwood Equity Partners (CEQP) for $7.1 billion. Those leverage-neutral deals will increase its cash-flow per unit, giving it more money to support a growing distribution. The company's dual growth drivers power its plan of increasing its already high-yielding distribution by 3% to 5% per year.
Massive upside potential
Energy Transfer's big-time distribution is only part of the appeal. The MLP also trades at a deeply discounted valuation despite its strong financial and growth profiles:
Image source: Crestwood Equity Partners.
As that slide shows, the consensus price target from Wall Street analysts for Energy Transfer is around $17 per unit, implying more than 30% upside from its recent price. Meanwhile, if the company traded at the same valuation multiple as its peers in the pipeline industry, units would fetch around $24 apiece, implying over 80% upside potential. It's also worth noting that this is before factoring in the potential value accretion from the Crestwood deal.
One factor impacting the company's valuation is the uncertainty surrounding its Lake Charles LNG project. Energy Transfer has experienced significant delays in developing the project, which recently led the Department of Energy to reject extending its authorization. Because of that, Energy Transfer is starting over with the approval process. It recently secured several more customers to support the project and is close to bringing on joint-venture partners to help finance its construction.
An analyst at Citi recently highlighted Lake Charles as a potential positive catalyst for the MLP. The analyst wrote, "We don't believe Lake Charles is priced into ET's unit price." It's one of the drivers of the bank's buy rating and $16 price target on the MLP. If the company finally approves the project, it could provide Energy Transfer's valuation with a meaningful boost.
The market also isn't giving Energy Transfer enough credit for its progress in shoring up its financial position over the past two years. The MLP has significantly deleveraged its balance sheet following a 50% distribution cut in 2020 to free up cash to pay off debt. With its balance sheet back on a firm foundation, Energy Transfer is now reaccelerating growth by making more acquisitions and sanctioning additional expansion projects. Its improved financial position also enabled the MLP to reset its distribution back to its pre-pandemic level, which it now aims to grow by 3% to 5% per year. Energy Transfer's valuation should improve as the market starts seeing a higher growth rate.
Big-time total return potential
Energy Transfer offers investors the best of both worlds. It pays a substantial quarterly cash distribution, making it ideal for income-seeking investors. In addition, it has tremendous upside potential because it trades at a steeply discounted valuation compared to analysts' price targets and its peer-group average. Those factors set the MLP up to potentially produce massive total returns for investors in the coming years. That makes it look like a very compelling investment opportunity right now.
