Energy Transfer (ET 1.67%) is going to be a tough stock for some dividend investors to buy. There are good reasons for this, but management insists it has positioned the business for slow and steady growth in the years ahead. If you can look past the history, here's what the next 10 years might look like.
Energy Transfer's ugly past
Trust will be the biggest issue for conservative dividend investors. In 2020, Energy Transfer cut its distribution in half. That was a difficult time for the energy sector and the world, given the coronavirus pandemic. However, if you were trying to live off your dividends, that cut might have been a painful hit to your finances. Notably, other high-yielding competitors continued to increase their distributions, including Enterprise Products Partners and Enbridge.
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In 2016, another difficult period for the energy sector, Energy Transfer agreed to buy peer Williams Companies and then got cold feet. After warning that consummating the deal could lead to a dividend cut, Energy Transfer issued convertible securities. Those securities appeared as if they would protect the buyers from the dividend cut that management was warning about. The CEO at the time bought a lot of those convertibles. The Williams deal was ultimately scuttled, but it would be understandable if investors came away from that event wondering if insiders were being favored over shareholders.
But things are different now. For starters, the CEO at the time of the Williams debacle is no longer in that role. And the distribution is not only growing again but is above where it was prior to the 2020 dividend cut. The biggest change, however, is that Energy Transfer is now calling for regular distribution growth of 3% to 5% a year. That's more exciting than it sounds.
Easily getting to 10%
Energy Transfer's distribution yield is currently 7.4%. Add 3% to that, the low end of the distribution growth target, and you get just over 10%. Investors generally expect returns of 10% from the broader market over time. If you are a dividend investor, Energy Transfer should sound pretty exciting.
However, what does the math actually look like? Dividend stocks tend to trade within yield ranges. To maintain its range, a stock has to rise when the dividend is increased. Energy Transfer's distribution is currently $1.33 per unit. In a decade, a 3% distribution growth rate would grow that figure to $1.79 per unit. A 5% growth rate would increase it to $1.82.
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Key Data Points
If you don't change Energy Transfer's current unit price, those ending distribution rates would both translate into yields of around 10%. However, if you assume the master limited partnership's (MLP's) unit price increases along with the distribution, the unit price would need to rise to around $24 to maintain the current yield of 7.4% or so. In other words, slow and steady distribution growth leads to slow and steady price growth, too.
Energy Transfer could be a high-yield gem
If you can overlook the past here, Energy Transfer could be an attractive income stock for investors looking to maximize the income their portfolio generates. That said, the most interesting thing about the 3%-to-5% forecast range is that it is enough to keep the distribution growing above the historical rate of inflation growth. So even if you spend every penny of the distribution, the buying power of that distribution is likely to be maintained, if not increased, over time. Any capital appreciation that comes along with that income stream could be seen as icing on the cake.
