Energy Transfer (ET 0.12%) pays a monster distribution. The master limited partnership (MLP) currently yields an eye-popping 9.3%. Usually, a yield that high is a warning sign that the payout isn't sustainable.
A quick glance at the company's recent third-quarter earnings might give uninformed investors the impression that it can't maintain its big-time distribution. However, a closer look shows that the company's cash flow is more than enough to support (and grow) its monster payout.
Drilling down into Energy Transfer's financial results
Most investors should be familiar with how to read a company's income statement. It's a crucial document that provides a snapshot of its financial performance in a period. Here's a visualization of Energy Transfer's income statement from the third quarter:
At first glance, that graphic suggests the MLP had a rough quarter. It shows that the company's revenue declined by nearly 10% to about $21 billion, while its net income slumped over 20% to around $1 billion. That net income number would be concerning, considering that Energy Transfer distributed $984 million in cash to its investors in the third quarter. It suggests the company is paying out virtually all its income to investors. That wouldn't be sustainable.
However, there's a lot more to the story. Energy companies like Energy Transfer are capital-intensive businesses. They invest a lot of money to build and maintain their energy infrastructure. Those investments come with certain tax benefits, including the ability to depreciate the value of their assets, which reduces their net income and, thus, their income tax liability.
You can see from that graphic that Energy Transfer recorded over $1.1 billion of depreciation, depletion, and amortization charges in the third quarter. These are noncash charges. Because of that, its actual cash flow was much higher than its reported net income. During the third quarter, Energy Transfer produced about $2 billion in distributable cash flow (DCF), which is free cash flow it could have paid to investors in distributions. DCF was up 25% from last year, fueled by record volumes across several of its systems. That easily covered its distribution level. It also covered the company's capital spending on growth ($418 million) and maintenance ($180 million) projects. It retained the rest to strengthen its already solid balance sheet.
Its cash flow is going to grow even bigger
Energy Transfer expects its already sizable cash flow to grow even larger in the future. The company recently closed its $7.1 billion acquisition of fellow MLP Crestwood Equity Partners. That company will provide a meaningful boost to Energy Transfer's earnings and cash flow in the coming quarters. Crestwood was on track to produce $430 million to $510 million in DCF this year as a stand-alone entity. Energy Transfer believes it can extract even more cash flow out of Crestwood's legacy assets by capturing merger synergies and other cost savings, initially targeting at least $40 million in savings.
In addition to the cash-flow boost from Crestwood, Energy Transfer is investing about $2 billion this year in growth capital projects. These investments will increase its cash flow in the future. They'll also grow its asset base, which it can continue depreciating.
The company expects to continue investing money to grow its business. It sees capital spending rising to a range of $2 billion to $3 billion annually, a rate it can easily support with excess cash flow after paying its distribution. It has many investment opportunities under development, including expanding its existing pipelines and export terminals, constructing a liquified natural gas export facility, and building out a lower-carbon energy platform. Those investments will increase its income and cash flow in the coming years.
Energy Transfer's growing cash flows support its plan to continue increasing its high-yielding distribution. The company aims to raise that payout by 3% to 5% per year.
An excellent income stock
Energy Transfer's midstream business generates lots of steady cash flow. That gives the MLP the money to cover its hefty distribution and growth-related investments with room to spare. The company's growth spending, along with its recently closed acquisition of Crestwood, will increase its cash flow, giving it the fuel to continue growing its distribution in the future. That makes it a very attractive option for income-seeking investors.
