ET - Energy Transfer: Promising Acquisitions And Expansion Endeavors

2023-12-08 04:10:05 ET

Summary

• Energy Transfer LP operates one of the largest and most diversified portfolios of energy assets in the US.
• The high cost of entry into the oil pipeline industry creates a barrier for new players.
• The company's asset diversification and geographic reach position it well to navigate market dynamics and capitalize on opportunities in the energy sector.

Thesis

Energy Transfer LP ( ET ) operates one of the largest and most diversified portfolios of energy assets in the United States, with more than 125, 000 miles of pipeline and associated energy infrastructure. It has a presence in 44 states and assets in all the major US production basins. Its core operations include intrastate and interstate transportation and storage assets; crude oil, natural gas liquids, and refined product transportation and terminal assets; and NGL fractionation. It owns Lake Charles LNG company and general partner interests, the incentive distribution rights and approximately 34% of outstanding common units of Sunoco LP (NYSE: SUN ), and the general partner interests and approximately 47% of the outstanding common units of USA Compression Partners, LP (NYSE: USAC ).

The management has a successful track record of successfully integrating 15 companies over the past two decades. Its Nederland Terminal is one of the largest single-owner, above-ground oil storage facilities in the US. It is one of the largest NGL exporters, nearly 20% of the world. It operates three export terminals and is the only logistics provider with facilities on both the US Gulf Coast and East Coast.

High cost of entry

The oil pipeline industry presents a formidable barrier to entry for new players, primarily due to the substantial capital investment required to establish and maintain pipeline infrastructure. The sheer magnitude of financial resources needed for land acquisition, engineering, construction, and regulatory compliance creates a significant deterrent for potential entrants. Moreover, the industry demands advanced technological expertise and operational know-how, further complicating the entry process for those lacking experience. Regulatory compliance adds an additional layer of complexity, with stringent standards for safety and environmental protection that necessitate a thorough understanding and commitment of resources.

Established players in the oil pipeline sector, like Kinder Morgan and Pembina Pipeline, enjoy economies of scale, allowing them to spread fixed costs over a larger volume of transported oil. This cost efficiency becomes a competitive advantage, making it challenging for new entrants to compete on a cost basis. The industry's long payback period and inherent risks, including those associated with unexpected events or technical failures, compound the challenges faced by newcomers. In essence, the high cost of entry into the oil pipeline industry arises from a convergence of financial, technological, and regulatory complexities, creating a robust barrier that protects existing players and contributes to the industry's consolidation among major entities.

Asset Diversification

The company's diverse range of activities in the United States spans natural gas operations, covering midstream and intrastate transportation and storage, interstate natural gas transportation and storage, as well as crude oil, natural gas liquids ((NGL)), and refined product transportation. This diversification involves intricate revenue streams, with the intrastate transportation and storage segment being influenced by customer capacity reservations and actual gas throughput. The midstream segment's results hinge on the margins earned from the gathering, transportation, purchase, and sale of natural gas volumes through pipeline systems and the processing of natural gas and NGL volumes.

In the NGL segment, revenues are primarily generated through dedicated or take-or-pay contracts, where customers commit to delivering the total output from specific processing plants connected to the NGL pipeline. Additionally, fees for storage and throughput contribute to revenue. The crude oil pipeline systems generate revenue through tariffs paid by shippers using transportation services filed with regulatory agencies.

The company's foray into LNG export adds another layer to its diversification strategy, with agreements signed and ongoing negotiations indicating a significant future impact on cash flows. The completion of the LNG project is expected to bring substantial incremental cash flows through increased natural gas transportation on the Trunkline pipeline system and other Energy Transfer pipelines upstream from Lake Charles. This strategic diversification across various segments positions the company to navigate market dynamics and capitalize on evolving opportunities within the energy sector.

Geographic Reach

The company operates an extensive network of natural gas transportation pipelines, totaling approximately 19,945 miles of interstate pipelines directly owned and operated, with an additional 7,085 miles through joint ventures. This vast interstate network spans the United States, offering comprehensive pipeline and storage services regulated by the Federal Energy Regulatory Commission (FERC). The midstream segment focuses on natural gas gathering, NGL pipelines, processing plants, treating facilities, and conditioning facilities concentrated in major producing basins across multiple states.

In addition to natural gas, the company's portfolio includes NGL and refined products, transportation, and services, comprising over 5,650 miles of NGL pipelines, terminals, fractionation facilities, and storage assets. These assets transport NGLs from various shale basins to key facilities in Texas and beyond. The crude oil operations involve transportation, acquisition, and marketing services, managing approximately 11,315 miles of crude oil trunk, and gathering pipelines and equity ownership in various crude oil pipeline systems.

Furthermore, the company engages in gas marketing activities, commodity trading, natural gas compression equipment business, and wholesale power trading, showcasing a diversified and comprehensive presence across the energy value chain. This extensive geographic footprint covers 44 states and all major basins in the United States, emphasizing the company's broad and strategic market reach.

Acquisition of Crestwood

Energy Transfer ( ET ) acquired Crestwood Equity Partners ( CEQP ), a move that strategically positions ET in key basins, particularly the Williston and Delaware basins. CEQP's substantial processing capacity in these basins complements ET's downstream fractionation capacity in Mont Belvieu, along with hydrocarbon export capabilities from Nederland, Texas, and the Marcus Hook complex in Philadelphia, Pennsylvania. This transaction extends ET's presence in the value chain, deepening its footprint in critical energy-producing regions.

The acquisition includes entry into the Powder River basin through gaining control of a premier gathering and processing system in that area. Additionally, the combination presents commercial synergy opportunities by integrating CEQP's Storage and Logistics business with ET's NGL and refined Products and Crude Oil assets. The merged entity anticipates an attractive portfolio of organic growth prospects around CEQP's footprint, tapping into new drilling activities and potential acquisitions.

Operational and cost synergies are expected across CEQP's total annual cost base of approximately $300 million, with the prospect of significant reductions upon integration into ET. The complementary asset footprints and operational scale in the Delaware and Williston basins offer substantial synergy realization potential. Furthermore, the optimization of CEQP's capital structure using ET's investment-grade balance sheet presents an opportunity to refinance existing debt at a lower capital cost.

Financials

Energy Transfer LP experienced a 9.59% year-over-year decline in revenue for the third quarter of 2023, with total revenue reaching $20.739 billion . This trend extended over the twelve months ending September 30, 2023, resulting in a 10.77% decrease, with annual revenue at $78.555 billion. Despite this revenue decline, the company witnessed positive trends in profitability. The gross profit for Q3 2023 increased by 5.81% compared to the same period last year, totaling $4.680 billion . Over the twelve months ending September 30, 2023, gross profit saw a 3.64% rise, reaching $17.731 billion.

Operational indicators reflected robust performance. Operating income surged by 13.18% in Q3 2023, amounting to $2.233 billion . Over the twelve months ending September 30, 2023, operating income saw a 4.13% increase, reaching $7.936 billion. The net income for Q3 2023 showed a decline of 48.16%, amounting to $0.466 billion. Over the twelve months ending September 30, 2023, net income faced a 19.17% decrease, reaching $3.315 billion.

The company demonstrated strength in EBITDA, indicating operational efficiency and profitability. EBITDA for Q3 2023 increased by 11.22% year-over-year, totaling $3.340 billion. Over the twelve months ending September 30, 2023, EBITDA grew by 4.43%, reaching $12.223 billion. Earnings per share ((EPS)) also experienced a downturn. In Q3 2023, EPS declined by 48.28% , reaching $0.15. Over the twelve months ending September 30, 2023, the decline persisted, with EPS at $1.07, reflecting a 19.55% decrease.

The balance sheet indicated a positive trajectory in terms of assets and liquidity. Total assets for Q3 2023 increased by 1.74%, reaching $107.571 billion. Cash on hand exhibited significant growth, rising by 57.67% to $0.514 billion. Long-term debt decreased slightly by 0.71%, reaching $47.075 billion. Shareholder equity saw a minimal decline of 0.02%, totaling $40.561 billion.

Valuation

For my valuation, I have assumed a terminal growth rate of 3% and a WACC of 9%. I have also used the tax rate to be the same as this year due to the nature of the investments of the company. There is no clear tax rate, as it has been using the tax breaks from its investing activities.

Employing a 5% growth rate for revenue projections, I considered both organic expansion and the impact of recent acquisitions, factoring in synergies derived from these strategic moves. Consequently, the intrinsic value is calculated at $18.09 per share, an increase of 32.9% from its current price. This reinforces my perspective that the stock presents a compelling buying opportunity, given its current undervaluation.

Risks

Regulatory Risk

Energy Transfer LP faces notable regulatory risks given its extensive operations across various states and involvement in interstate and intrastate activities, including exports. The rates charged by the company are subject to regulatory oversight, leaving limited room for pricing adjustments. The fixed nature of these rates implies that any changes or new regulations imposed by regulatory authorities could potentially impact the company's financial performance. The dependency on regulatory decisions introduces an element of uncertainty, as alterations in pricing structures or other regulatory measures may have direct implications on revenue and profitability.

Leverage

The company has a maturity of nearly $1 billion in debt in April 2024. The prevailing economic conditions, coupled with the company's credit rating of BBB by S&P, create a complex environment for refinancing endeavors. A BBB rating, while still investment-grade, suggests a moderate credit risk. However, in the current scenario, where market dynamics and investor sentiment play pivotal roles, obtaining favorable terms for refinancing becomes intricate. The difficulty lies not only in securing additional bonds but also in the broader context of market dynamics and investor sentiment.

Conclusion

After conducting a comprehensive analysis of the company, I am inclined to conclude that its fundamental strength positions it for a consistent flow of income, primarily in the form of dividends. The company's proactive engagement in acquisitions bodes well for future earnings, allowing it to expand market share and boost revenue through synergies. Given the current stock price of $13.61, which appears to undervalue the business, and the management's endeavors to achieve economies of scale through strategic acquisitions and consolidations, I would confidently recommend a BUY rating for this company.

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