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5 Reasons to Buy Energy Transfer Stock Like There's No Tomorrow
Key Points
Energy Transfer has improved its balance sheet and its contract structure.
The stock has a yield over 7% with a safe and growing distribution.
The company also is seeing solid opportunities due to increasing natural gas demand.
Energy Transfer (NYSE: ET) isn't a flashy name, but it has one of the best risk-reward profiles in the market right now and a high yield. It's one of the largest holdings in my portfolio.
Here are five reasons to buy the midstream energy company's stock like there's no tomorrow. Keep in mind, however, that investing in a master limited partnership means you'll get a Schedule K-1 tax form and need to take some extra steps with your tax filing.
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1. A rock-solid financial position
After getting overextended during its last growth cycle, Energy Transfer spent the past few years cleaning up its balance sheet. It cut its distribution in 2020 to reduce leverage, and since then, it has paid down debt and funded much of its growth through free cash flow.
Today, leverage is at the low end of the pipeline company's target range. On its most recent call with analysts, management said the balance sheet is the strongest it has ever been. That gives it the flexibility to invest in growth projects and return capital to shareholders without the worry of becoming overextended once again.
2. Predictable cash flow
Roughly 90% of Energy Transfer's earnings before interest, taxes, depreciation, and amortization (EBITDA) is from fee-based services, where it has no exposure to commodity prices. And many of its contracts are take-or-pay, meaning customers pay whether or not they use the service. That creates stable, recurring cash flow, which is exactly what supports its distribution and growth projects.
Last quarter, Energy Transfer said it had a high percentage of take-or-pay contracts. That also helps give the company some of the best visibility it has ever had.
3. A high yield with a safe and growing distribution
The company's stock offers a forward yield of 7.5% as I write this, and it's well covered. It is generating twice the cash it needs to support its distribution. Last quarter's distributable cash flow coverage multiple was 2.1, which gives management plenty of room to continue to increase it.
It has now raised its distribution for 13 consecutive quarters, and it's well above pre-2020 levels when it had to cut it. Given its coverage ratio, strong balance sheet, and take-or-pay contracts, Energy Transfer is well positioned to grow its distribution in the years ahead. Management plans to raise it by 3% to 5% annually.
Image source: Getty Images.
4. Increasing natural gas demand is a catalyst
Not only has Energy Transfer strengthened its balance sheet and improved its contract structure, the company is also back in growth mode. It plans $5 billion in capital expenditures this year, up from $3 billion last year, and is targeting mid-teens returns on its project slate. These aren't speculative projects; they are tied to real demand with long-term contracts in place.
One of its biggest projects is the Hugh Brinson pipeline, which is designed to move natural gas out of the Permian Basin in West Texas to meet growing power demand elsewhere in the state.
Energy Transfer has also made progress on its long-delayed Lake Charles liquified natural gas (LNG) project and signed a cost-sharing deal with MidOcean Energy and several other agreements. If the project proceeds, it will open up a new growth avenue tied to LNG exports, with demand expected to rise 60% by 2040.
At the same time, artificial intelligence (AI) data centers are becoming a potential source of incremental demand. The company signed a deal with CloudBurst to supply gas to a new AI-focused data center it plans to build in Texas.
Management has also said it's in active discussions with more than 60 power plants and over 200 data centers across 14 states. These opportunities require relatively little capital and can generate quick returns.
5. The stock looks too cheap
Even with everything going right, Energy Transfer still trades at a forward enterprise-value-to-EBITDA multiple of just 8. That's well below its historical average and a discount to most of its peers. Meanwhile, from 2011 to 2016, midstream master limited partnerships (MLPs) traded at an average EBITDA multiple of around 13.7.
Investors still haven't fully adjusted to how much stronger Energy Transfer's business is today. The company has cleaned up its balance sheet, improved its contracts, and is pursuing disciplined growth with solid returns. It offers growth to go along with an enticing yield, making it a solid stock for income-focused investors.
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Geoffrey Seiler has positions in Energy Transfer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.