Energy Transfer: Solid Results Show The Company’s Value As A Core Income Holding (NYSE:ET)

On Wednesday, February 14, 2024, Energy Transfer LP (NYSE:ET), one of the largest midstream master limited partnerships (“MLPs”) in the United States, announced its fourth-quarter 2023 earnings results. At first glance, the company’s earnings results appear somewhat mixed, as Energy Transfer missed the expectations of its analysts in terms of top-line revenue, although it did still manage an earnings beat. For its part, the market appeared to be reasonably satisfied with the earnings report, as it pushed Energy Transfer’s common unit price up 3.44% over the five-day period surrounding the announcement. That was a better performance than the 0.06% gain that the S&P 500 Index (SP500) managed. It also managed to beat the Alerian MLP ETF (AMLP) over the same period:

The fact that Energy Transfer managed to beat the Alerian MLP Index is interesting, as Energy Transfer itself is the largest component of the index. The partnership accounts for the full 10.3% of the index:

As such, Energy Transfer must have significantly outperformed many other master limited partnerships over the period, as the performance of the other companies needed to be weak enough to overcome Energy Transfer’s strength and pull down the performance of the overall index. This is not exactly surprising, though, as Energy Transfer has been one of the better midstream companies coming out of the pandemic despite annoying many of its investors with the distribution cut.

A closer look at Energy Transfer’s earnings report reveals that the market could be right about it, as this report was quite good. The revenue miss can be easily overlooked, especially since revenue is not exactly the most important thing for a company like this. Energy Transfer managed to achieve strong year-over-year cash flow growth, which further improved the company’s ability to cover its attractive 8.74% current yield. The company also continues to have a fairly strong growth pipeline that should allow it to continue to deliver strong performance and investment returns over the coming years.

Overall, these results clearly show that Energy Transfer continues to be a solid holding for any investor who is interested in receiving a large check from their savings every few months.

Earnings Results Analysis

As regular readers are no doubt well aware, it is my usual practice to share the highlights from a company’s earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Energy Transfer’s fourth-quarter 2023 earnings report:

• Energy Transfer brought in total revenue of $20.5320 billion in the fourth quarter of 2023. This represents a 0.15% increase over the $20.5010 billion that the company reported in the prior year quarter.
• The company reported an operating income of $2.1650 billion in the fourth quarter of the most recent year. This represents a 19.88% increase over the $1.8060 billion that the company reported in the year-ago quarter.
• Energy Transfer’s interstate natural gas pipelines moved an average of 16.651 trillion BTU per day of natural gas during the reporting period. This represents a 5.25% increase over the 15.821 trillion BTU per day of natural gas that the company’s interstate infrastructure moved on average during the equivalent quarter of last year.
• The company reported a distributable cash flow of $1.928 billion in the current quarter. This represents a 1.90% increase over the $1.892 billion that the company reported in the corresponding quarter of last year.
• Energy Transfer reported a net income of $1.3260 billion in the fourth quarter of 2023. This represents a 14.90% improvement over the $1.1540 billion that the company reported in the fourth quarter of 2022.

It seems essentially certain that the first thing that anyone reviewing these highlights will notice is that Energy Transfer showed improvement compared to the prior year’s quarter in every measure of financial performance. This is a divergence from what we have generally seen over the course of 2023. In particular, Energy Transfer usually reported weaker revenue during each quarter of 2023 than it did for the prior year quarter. We can see this here:

Notice how the company’s revenues typically declined year-over-year during 2023:

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As we can see, the fourth quarter was the only one in which Energy Transfer managed to deliver a year-over-year revenue increase. The company does not provide a reason for this in its earnings press release, but one possibility was almost certainly the merger with Crestwood Equity Partners that was consummated in early November. The company describes this transaction in a press release dated November 3. From the document:

Energy Transfer LP announced today the completion of its previously announced merger with Crestwood Equity Partners LP.

…

As a result of the acquisition, Energy Transfer now owns and operates more than 125,000 miles of pipelines and related assets in all the major U.S. producing regions and markets across 41 states, further enhancing its leadership position in the midstream sector. The transaction is immediately accretive to distributable cash flow per unit for Energy Transfer and adds significant cash flows from the firm, long-term contracts, and significant acreage dedications. Additionally, the combined operations of the two companies are expected to generate initial annual run-rate cost and efficiency synergies of at least $40 million before additional anticipated benefits of financial and commercial synergies.

As I have noted in various previous articles over the course of 2023, the year-over-year revenue declines that we have seen across the midstream sector have been mostly caused by the low natural gas price environment. This continued to be true in the fourth quarter, as we can see here:

This chart shows the price of natural gas at Henry Hub from October 1, 2022, to December 31, 2023. As we can clearly see, natural gas prices are down 61.13% over the period. This has impacted the revenues of many of the largest midstream companies due to the fact that they all have large natural gas processing operations. Energy Transfer is no exception to this, as we can see on its asset map:

Each square symbol on the map is a natural gas processing plant. We can clearly see that the company owns numerous ones throughout the Bakken Shale, Permian Basin, and much of Oklahoma. These plants operate much like crude oil refineries, as they are margin-based businesses. Energy Transfer buys the unprocessed natural gas, runs it through the plant, and sells the finished products (dry natural gas and natural gas liquids). As the buying and selling prices are both based on current commodity prices, the business model of these processing plants can cause Energy Transfer to have fairly large revenue swings over time. We can see that quite clearly in the company’s 2023 results relative to its 2022 results.

In the case of the company’s fourth-quarter earnings results, it appears that the additional revenue that the company received from the takeover of Crestwood Equity Partners’ assets was enough to offset the revenue decline from the lower natural gas pricing environment. We can expect that this acquisition will help to stimulate further revenue growth if and when natural gas prices recover, although that could be a ways off as a supply glut continues to plague the market.

In a previous article on Energy Transfer, I explained the company’s basic business model:

In short, Energy Transfer enters into long-term (usually five to fifteen years in length) contracts with its customers under which the company provides transportation for the customer’s hydrocarbon products using its network of pipeline infrastructure. In exchange, the customer compensates Energy Transfer based on the volume of resources that the partnership handles, not on their value.

As has been the case over most of this year, Energy Transfer generally saw its transported volumes increase compared to the prior-year quarter:

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As we can see, every one of the company’s volume-based lines of business saw their overall volumes increase year-over-year except for a very slight decrease in the intrastate transportation and storage unit. There are a few reasons for this, including the acquisitions that the company completed over the past year and the growth projects that it managed to bring online. However, another major contributing factor is the fact that the production of natural gas and crude oil increased over the course of 2023. The U.S. Energy Information Administration confirms this:

We can see that the Permian Basin, Bakken Shale, and Appalachian Basins saw production volumes increase over the period. While the Eagle Ford and Anadarko experienced slight decreases, that was not enough to offset the production increases elsewhere. As such, the production of both crude oil and natural gas generally increased in the Continental United States over the course of 2023. Naturally, someone needs to bring the incremental resources to the market where they can be sold or else there would be no reason to produce them. Energy Transfer is one of the largest pipeline operators in the United States, and pipelines are typically considered the most affordable and efficient way to move hydrocarbon resources. Thus, we can naturally assume that Energy Transfer will secure contracts for at least some of this production growth. That is exactly what we saw over the past year. Energy Transfer’s cash flows directly correlate to the volume of resources that move through its pipelines, so this dynamic was a driving factor in the firm’s year-over-year cash flow growth.

There is no reason to expect that the production of crude oil will decline going forward absent a substantial decline in oil prices, which seems unlikely given the current supply and demand dynamics in the market. While natural gas producers have been cutting back a bit on production growth recently, there is likewise no reason to expect that there will be a steep decline here either. Thus, Energy Transfer should be able to continue to generate cash flows and today’s levels going forward. In previous articles, we have seen that the company has a number of projects under construction that will increase its ability to carry more resources, so cash flow growth is the most likely scenario. This will obviously benefit the company’s investors.

Financial Considerations

As I pointed out in my last article on Energy Transfer:

It is always important that we analyze the way that a company finances its operations before investing in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. That is typically accomplished by issuing new debt and using the proceeds to repay the existing debt. As new debt is issued with an interest rate that corresponds to the market interest rate at the time of issuance, this can cause a company’s interest expenses to go up following the rollover. That is an especially big concern today because interest rates are at the highest levels that we have seen since 2001.

As we saw in our recent discussion of Enbridge Inc.’s (ENB) quarterly results, some companies in the midstream sector have begun to feel the pressure of higher interest rates on their financial performance. Enbridge, for example, has been seeing its interest expenses rise over the past few quarters. This is also true for Energy Transfer. Here are the company’s total and net interest expenses over the past eleven quarters:

We can certainly see that Energy Transfer’s interest expenses have increased significantly since 2022, as every quarter during that year witnessed a lower level of interest expenses for this company. However, curiously, Energy Transfer’s interest expenses are currently at roughly the same level that the company had in the middle of 2021. As everyone reading this is no doubt well aware, interest rates were at all-time lows during that year as the Federal Reserve was trying to stimulate the economy following the devastating effects of the COVID-19 lockdowns.

The fact that Energy Transfer’s interest expenses have been rising this year has been a drag on the company’s reported net income. More importantly, interest expenses are a drag on the company’s distributable cash flow because Energy Transfer has to pay interest on its debt before it can distribute any money to the common unitholders. This can make the company’s interest expenses something of a nuisance for those who wish to earn as high an income as possible from the companies that they hold in their portfolios. However, as long as the things that the company uses its debt to purchase produce higher cash flow than the interest that it has to pay on the funds that it borrowed to make the capital investments, unitholders are still better off even with the higher interest. That seems to be the case, as Energy Transfer’s distributable cash flow in the fourth quarter of 2023 was higher than it was in the prior-year quarter. However, as its interest expenses increased by more than the distributable cash flow did, it suggests that much of the cash generated by the company’s new capital purchases went to debt service as opposed to the common equity.

The most important thing for our analysis though is to determine how well the company can carry its debt. The usual way that we judge this is by looking at the company’s leverage ratio, which is also known as the consolidated debt-to-adjusted EBITDA ratio. This ratio basically tells us how many years it would take the company to completely pay off its debt if it were to devote all of its pre-tax cash flow to that task.

As of December 31, 2023, Energy Transfer had a consolidated debt load of $52.1580 billion. The company’s trailing twelve-month adjusted EBITDA is $13.6980 billion. This gives the company a leverage ratio of 3.81x, which is a bit worse than the 3.45x ratio that the company had the last time that we discussed it. The increase in the company’s leverage ratio is disappointing, but it is still well below the 5.0x that Wall Street analysts typically consider acceptable for a midstream partnership. It is also below the 4.0x ratio that I like to see in order to get a margin of safety. Thus, we probably do not need to worry too much about Energy Transfer’s debt right now.

Distribution Analysis

The usual reason for purchasing shares of a midstream master limited partnership like Energy Transfer is because of the very high distribution yields that these companies typically possess. Energy Transfer, for example, yields 8.74% at the current price. This is obviously substantially higher than most other things in the market, and it is one of the few common equities available in the market that boasts a higher yield than a typical money market fund. Unfortunately, the company has not always been consistent with respect to its distribution. As we can see here, Energy Transfer cut the payout severely back in 2020, but it has since then restored it:

While the company has restored its distribution to the previous levels, the fact that it cut at all has likely weakened the opinion that many investors have of the company. Indeed, a simple look through the comments section of any article published on Seeking Alpha about this company usually has at least one person upset about management cutting the distribution following the outbreak of the pandemic. This is especially true because the company’s cash flow did not decline around that time, so it should have been able to avoid a distribution cut. Other midstream partnerships such as Enterprise Products Partners L.P. (EPD) and MPLX LP (MPLX) did not cut in the same environment, so those investors who are determined to avoid any distribution cut may gravitate to one of those two companies.

However, anyone who purchases the common units today will receive the current distribution at the current yield. This individual will not be affected by the actions that the company has taken in the past. As such, the most important thing for someone who is considering purchasing the company’s common units today is how well it can sustain the distribution going forward. Let us investigate this.

The usual way in which we analyze a midstream partnership’s ability to cover its distribution is by looking at its distributable cash flow. Distributable cash flow is a non-GAAP metric that theoretically tells us the amount of cash that was generated by a company’s ordinary operations and is available for distribution to limited partners.

As mentioned in the highlights, Energy Transfer reported a distributable cash flow of $1.928 billion in the fourth quarter of 2023. The company’s distributions to the partners totaled $1.062 billion in the quarter, so the distributable cash flow was enough to cover the payout 1.82 times over. Wall Street analysts generally consider anything over 1.20x to be sustainable over the long term. However, I am more conservative and prefer this ratio to be 1.30x or higher to add a margin of safety to the position. As we can clearly see, Energy Transfer satisfies even this stricter criterion. As such, we probably do not need to worry too much about the company’s ability to sustain its distribution going forward.

Conclusion

In conclusion, Energy Transfer has a well-deserved reputation as a solid core holding for any income-focused investor. The company did tarnish its reputation somewhat with the cutback in 2020, but it has restored its payout since then and delivered remarkable growth. The latest results show the company continuing to deliver on this growth trajectory. Overall, we see largely what we have come to expect from Energy Transfer LP, and it should prove to be a good holding for anyone who is seeking to earn income today.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.