Energy Transfer (ET +1.96%) has delivered a strong performance over the past year. Units of the master limited partnership (MLP) are up over 19%. On top of that, the MLP has paid a high-yielding (and growing distribution). That has pushed its total return to more than 31% over the last 12 months.
Despite that rally, Energy Transfer still trades at a fairly attractive valuation. Meanwhile, the MLP has lots of fuel to grow its distribution, which currently yields over 9% even after the nearly 20% surge in its unit price. These factors still make it look like an appealing investment.
NYSE: ET
Key Data Points
Lots of upside potential
Units of Energy Transfer currently trade at less than $14 apiece. That's an attractive level compared to its peers and where analysts believe the MLP should trade:
Image source: Crestwood Equity Partners.
As that slide shows, the current median analyst price target for Energy Transfer is $17 per unit. That implies the MLP has more than 20% upside from its recent price. Meanwhile, if the MLP traded at the same valuation multiple as its peers, it would sell for around $24 per unit. That puts its upside potential above 75%.
These values don't include the positive impact of the company's accretive acquisition of fellow MLP Crestwood Equity Partners (CEQP +0.00%), which should close before the end of this year. The $7.1 billion deal will be immediately accretive to Energy Transfer's distributable cash flow per unit upon closing. Meanwhile, the company expects to capture at least $40 million of annual cost savings, half of which it should realize next year, with the balance in 2025. On top of that, Energy Transfer sees the potential of capturing additional cost savings by using its investment-grade credit rating to refinance Crestwood's higher-cost debt at lower rates. Higher earnings from this deal will make Energy Transfer more valuable in the future.
A strong payout
Energy Transfer's low valuation is a big driver of its high distribution yield. Its payout is higher than other large-scale midstream companies despite having a similar or lower payout ratio. For example, while it has the same payout ratio as Enterprise Products Partners (EPD +1.03%) at around 53%, its fellow MLP has a lower distribution yield of 7.3%. Meanwhile, it has a much lower payout ratio than Enbridge (ENB +0.70%), which targets 60% to 70%. Enbridge has a lower dividend yield (currently 8%) despite the higher payout ratio.
Energy Transfer's relatively low payout ratio enables it to retain significant excess free cash flow. That gives it money to fund expansion projects, strengthen its balance sheet, and return additional cash to investors through unit repurchases.
The company's capital allocation strategy helps drive its view that it can increase its distribution by 3% to 5% per year. Expansion projects will help grow its cash flow. Meanwhile, debt reduction will reduce interest expenses, freeing up additional cash flow. It will also give the company more financial flexibility to continue making accretive acquisitions as opportunities arise. Finally, unit repurchases will reduce outstanding units. That will help grow its distribution per unit since it will make distribution payments across fewer units in the future.
Energy Transfer's strategy is the same as that of Enterprise Products Partners and Enbridge. Those rivals also generate significant excess free cash after funding their high-yielding payouts. They use that cash to grow their payouts, fund expansion projects, make repurchases, and maintain strong balance sheets. Despite those similarities, Energy Transfer isn't getting the same credit since it has a lower valuation and higher yield.
Still an attractive investment
Energy Transfer still looks like a buy even after its rally over the past year. Its valuation remains relatively low. That's why it has a higher yield than its peers despite similar or better financial metrics and capital allocation strategies. Add that higher payout to its upside potential, and Energy Transfer could continue producing robust total returns.
