Energy Transfer (ET 0.26%) has many attractive things to offer investors. The list includes a large 7.2% distribution yield, a diversified and fee-supported midstream business, an investment grade rated balance sheet, and $5 billion in growth spending in 2025 (with more investment opportunities waiting in the wings). For conservative income investors, however, there's one issue that might keep this North American midstream giant on the no-buy list.
Energy Transfer makes a hard call in 2020
Energy Transfer is clearly an income stock. Investors buying it are most likely looking for the midstream master limited partnership (MLP) to pay a reliable distribution. In fact, the hope is probably for regular distribution increases over time. Energy Transfer has let investors down on this front.
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To be fair, the energy sector was in a deep downturn in 2020 when Energy Transfer cut its distribution in half. The efforts to slow the spread of the coronavirus pandemic led to economic shutdowns the world over. Oil prices plunged, actually falling below zero in the United States for a brief moment.
It was a highly uncertain time, and Energy Transfer made the decision to retain cash flow by cutting its distribution. That cash flow was directed to shoring up the MLP's balance sheet. It wasn't a bad decision for the business, but it is a choice that could have left income investors in the lurch if they were counting on that income to pay for daily living expenses.
What's important to note here is that midstream peers like Enterprise Products Partners and Enbridge didn't cut their dividends. In fact, both of these competitors increased their dividends in 2020. Enterprise's distribution has now been increased for 26 consecutive years, while Enbridge's dividend streak is up to 30 years.
Energy Transfer's 2020 cut wasn't the first concerning decision
If the 2020 decision to halve the distribution was the only issue, conservative investors might be able to look the other way. After all, the distribution returned to growth fairly quickly and is now above where it was prior to the cut. The problem is that the last time the energy sector was in a deep funk, there was another questionable move made.
The year was 2016, and Energy Transfer had agreed to buy peer Williams. The energy downturn at the time made completing the deal problematic, with Energy Transfer saying that closing as planned would require a dividend cut, material additions of debt, or perhaps even both. Management decided it no longer wanted to buy Williams, even though it had a definitive deal to do so.
In an attempt to scuttle the deal, Energy Transfer sold convertible securities, a large portion of which went to the CEO at the time. It seems as though those securities would have protected the CEO from the effect of a dividend cut if one had been made.
It was an ugly period, and Energy Transfer did, eventually, manage to end the merger it had agreed to. But the case wound up in court and Energy Transfer lost, with Williams being awarded hundreds of millions of dollars in damages. While it may have been the correct decision for Energy Transfer to get out of the Williams deal, the process could legitimately leave more conservative investors with trust issues.
Neither Enterprise Products Partners nor Enbridge have anything similar clouding their backgrounds. While they have slightly lower yields, at 6.9% and 6%, respectively, conservative investors will probably sleep better at night owning either of these midstream giants over Energy Transfer.
If you need reliable income, Energy Transfer probably isn't for you
There are many things to like about Energy Transfer today. And, perhaps, past trust issues are really in the past. But for dividend investors trying to live off the income their portfolios generate, the history at Energy Transfer makes it a tough investment to love. Lower-yielding and more reliable income investments Enterprise and Enbridge will probably be better options for most.
