ET - Energy Transfer Q3 Earnings Preview: What To Expect

2023-10-30 09:00:00 ET

Summary

• Energy Transfer LP will report its Q3 earnings results post-market on November 1, with analysts expecting an 11% decline in revenues.
• Energy Transfer's profits are not heavily dependent on top-line performance due to the nature of its business.
• ET's strong cash flows, dividend reinstatement, debt reduction efforts, and potential for value-creating acquisitions make it an attractive investment.

Article Thesis

Energy Transfer LP (ET) will report its quarterly earnings results for the third quarter post-market on November 1. In this article, we will take a look at what investors can expect from the upcoming earnings results while also taking a look at the longer term when it comes to an investment in Energy Transfer stock.

Energy Transfer's Upcoming Q3 Results

On November 1, following the market's close, Energy Transfer LP will report its Q3 earnings results. Analysts are predicting that the company will report a top-line result of $20.4 billion. This is around 11% less than the revenues the company generated during the previous year's quarter. While that doesn't sound great, the forecasted revenue decline isn't a problem - and Energy Transfer is one of the few companies where this holds true. The company's revenues are partially dependent on commodity prices, but so are the company's costs. Profits thus do not depend a lot on the sales the company generates, which is why ET's top-line performance is not overly important.

We see this when we look at Energy Transfer's second-quarter earnings results: The company reported a hefty sales decline of 29% compared to the previous year's quarter (when commodity prices were pretty high), but EBITDA nevertheless declined by just 3% year-over-year. I expect that we will see something comparable when ET reports its Q3 results: The double-digit sales decline has most likely not caused a sizeable EBITDA decline. ET could even report a small EBITDA increase compared to the third quarter of fiscal 2022, which naturally would be a very nice result.

Analysts are forecasting that Energy Transfer will report earnings per share of $0.33, which would be up versus the previous year's quarter. Of course, net profits are not the most important metric for Energy Transfer. The company's asset base is very capital-intensive, due to the pipelines and storage assets being worth many billions of dollars. This causes high depreciation charges, but those do not really reflect the value decline of these assets. While depreciation may reflect the value loss of a vehicle accurately, depreciation charges do not really reflect the value change of a long-lived asset such as a pipeline. Maintenance costs are pretty low, and one could argue that the value of these pipes actually rises over time, due to two reasons:

First, fee-based contracts oftentimes cause rising cash flows over time, which is why an investor might actually pay more for a pipe today, compared to 10 or 20 years ago, when the pipe generated smaller cash flows.

Second, building new pipelines has become harder and harder in recent years. High prices for steel and labor, as well as tough regulation, mean that building out a new pipeline has become very costly, or, in some cases, almost impossible. This increases the value of the pipes that are already in the ground today, as they become ever harder to replace.

So while Energy Transfer records massive depreciation charges, the value of its assets does not drop all that much - or even rises in some cases. This artificially depresses Energy Transfer's profits. Cash flows, where depreciation is not a factor as it is a non-cash item, are generally a lot higher, as we can see in the following chart:

We see that Energy Transfer's cash flows are around 2.5x higher than its net profits, which is why Energy Transfer is able to pay out nice dividends while still having ample cash left over for debt reduction, acquisitions, and investments in new assets.

The company has guided towards an adjusted EBITDA of $13.1 billion to $13.4 billion, while EBITDA during the first two quarters totaled $6.6 billion. The result for the second half of the current year should thus be relatively comparable, potentially slightly better. Since Q1 and Q4, when the temperature is lower and when more natural gas is burned for heating purposes, are the stronger quarters, Q3 will likely be somewhat worse than Q4 - which is not a reason for worry, of course, as it is a rather typical seasonal pattern for midstream businesses with natural gas exposure. I thus estimate that Energy Transfer's EBITDA in Q3 will be around $3.2 billion, with around $3.5 billion for the fourth quarter.

Energy Transfer: Creating Value With Its Strong Cash Flows

Energy Transfer has had a very volatile stock price over the last couple of years. Reasons for that include the dividend reduction during the COVID pandemic, worries about the company's debt load, uncertainties about the company's strategy and potential overspending on M&A played a role as well.

However, the company has proven that it is focused on generating value for its owners, by generating shareholder value in different ways:

• The company has worked hard on reinstating its dividend and achieved that goal in early 2023. Since then, the company has offered additional dividend raises. While those were not particularly massive, at around 1% per quarter, they nevertheless allowed Energy Transfer's dividend to rise to a new all-time high. The combination of a high initial dividend yield - 9.5% at current prices - and a mid-single-digit dividend growth rate is quite attractive for income-oriented investors. Thanks to the fact that the dividend payout ratio, looking at distributable cash flows (operating cash flows minus maintenance capital expenditures), is far from high, at around 50%, there is a lot of room for further distribution increases over time.
• Energy Transfer has also been working on the debt theme. Companies with a lot of expensive long-lived assets, including most energy midstream companies, employ a lot of debt to finance some of the expensive assets they own. This is not a problem per se, as long as these assets generate sufficient cash flows and as long as these assets are financed with long-term debt. This holds true for Energy Transfer: Cash flows are massive, and the company does not have to refinance a large portion of its debt per year. This also means that interest rate increases don't impact Energy Transfer a lot in the near term - the company's interest costs only increase when debt is being refinanced while existing fixed-rate debt is not affected. Still, some investors have worried about what ET's debt load means for the future, and Energy Transfer has been working on that in the recent past: Long-term debt stood at $45 billion at the end of the second quarter, which was down $3.5 billion compared to the beginning of the current year. The peak was north of $50 billion, thus things are moving in the right direction. At the same time, EBITDA is growing, meaning the company's leverage ratio (net debt to EBITDA) is improving even faster. I expect that Energy Transfer is going to pay down some debt over the coming years, although this will not be the sole focus. Still, the strong cash flows will allow Energy Transfer to put some cash towards debt reduction in the coming years, either via bond buybacks or by paying back maturing debt with existing cash.
• While many investors believe that Energy Transfer has been too aggressive with M&A at times in the past, it is not necessary for Energy Transfer to completely forego acquisitions in the future. Empire building, i.e. chasing growth for the sake of growth, is bad, but that does not mean that all M&A is bad. When Energy Transfer makes tuck-in acquisitions at the right price and valuation, those can create value for shareholders for sure, especially when substantial synergies can be captured.

Is ET Stock A Good Investment?

Energy Transfer has seen its shares climb by 13% so far this year, but shares are not expensive. Today, shares offer a massive dividend yield of almost 10% while the distributable cash flow yield is north of 20% at current prices. While the entire midstream industry is far from expensive, Energy Transfer remains cheap even compared to its inexpensive peers.

Looking at the enterprise value to EBITDA ratio, which accounts for debt and cash held on the balance sheet, the conclusion is the same: At just 7.3x EBITDA, Energy Transfer is a pretty inexpensive stock today.

A low valuation does not necessarily result in share price gains, especially not in a short period of time. But buying shares that trade at inexpensive valuations nevertheless can work out well -- catalysts such as further debt reduction, further dividend increases, etc. could result in a re-rating and a higher valuation. And at the same time, a low valuation limits the downside potential for the stock. I thus remain bullish on Energy Transfer LP.

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