ET - Energy Transfer: Redemption Part II

2024-01-12 08:00:00 ET

Summary

• Energy Transfer LP plans to redeem its outstanding preferred units and refinance existing debt through the issuance of senior notes and junior subordinated notes.
• The market has priced in the potential redemption of the preferred units, with minimal impact on their trading prices.
• We look at two plays on the setup.

On our July 2023 coverage of Energy Transfer ( ET ) and its preferred shares, we opined that these were very likely to be redeemed. The cost of these preferred shares were prohibitive in relationship to almost everything else. While management might have not confirmed this plan, the odds were quite high for us. Specifically we said,

Our bet is that this will be called very shortly. ET certainly has the free cash flow to do it. Yes, there are MLPs out there like NuStar Energy L.P. (NS), paying well into double digits on its preferred shares. But even they are redeeming their most expensive preferred shares to the extent they can.

Source: Redemption

Well, that just happened.

Energy Transfer LP today announced its intention, subject to market and other conditions, to concurrently offer senior notes due 2034 and senior notes due 2054 (together, the "senior notes") and fixed-to-fixed reset rate junior subordinated notes due 2054 (the "junior subordinated notes") in separate registered public offerings. Energy Transfer intends to use the net proceeds from the concurrent offerings to refinance existing indebtedness, including borrowings under its revolving credit facility, to redeem all of its outstanding Series C Fixed-to-Floating Rate Cumulative Redeemable Perpetual Preferred Units ( ET.PR.C ), Series D Fixed-to-Floating Rate Cumulative Redeemable Perpetual Preferred Units ( ET.PR.D ) and, when redeemable on May 15, 2024, Series E Fixed-to-Floating Rate Cumulative Redeemable Perpetual Preferred Units ( ET.PR.E ) and for general partnership purposes. This press release does not constitute a notice of redemption with respect to, or an offer to purchase, any indebtedness or the select preferred units.

Source: Energy Transfer

We look at the impact on existing shares till redemption and tell you whether or not you should stay invested in the one that is not being redeemed.

The Impact

ET.PR.E had the strongest move on the news, though even that was marginal.

The other two barely moved. As we expected, the market was pricing in the potential redemption and there was little to add on. At present, all 3 are trading right next to par when you strip out their next January 31, 2024, distributions. For ET.PR.D and ET.PR.C, we would just hold on until redemption. ET.PR.E is different than the other two. It has not yet reset to float (which of course it won't) and it is not past the call date.

On and after May 15, 2024, distributions on the Series E Preferred Units will accumulate for each distribution period at a percentage of the $25.00 liquidation preference equal to an annual floating rate of the three-month LIBOR plus a spread of 5.161% per annum.

Source: Preferred Stock Channel

You can rest assured that ET will get these removed at the first legal day that they can. But even considering that, there is a play here for a shorter term cash-like vehicle. If you strip out the accumulated distributions, ET.PR.E is trading slightly under par at $25.32. So you have a chance to earn 7.6% yield on a cash-like vehicle till redemption. Of course, our stance will open up the floor to comments on the time-honored punching bag known as the K-1. If you are comfortable doing it, do it, if not, we guess it is a pass.

Energy Transfer LP 9.250% FXD PFD I ( ET.PR.I )

With ET's main preferreds being taken out, the one that was inherited from Crestwood Equity Partners LP, came into the limelight. These cannot be called. On our last coverage we had called them undervalued and suggested they should trade at $11.11.

Even using the BB level yields, we can see that ET.PR.I is undervalued. Plus, ET.PR.I has no call risk and a deep embedded option on yields really catering in a deflationary shock. Worst case here, we think it should trade 50 basis points wide of the BB yields. So we would envision this trading with a 7.60% yield and that would get the price up to $11.11.

Source: A Look At The Undervalued Crestwood Preferred Shares

One additional area we can look for pricing is the yield on the junior debt which ET is issuing. These are equivalent to the preferred shares and rated at BB by Fitch. These 30 year junior notes priced exactly at 8%.

Energy Transfer announced the pricing of its concurrent offerings of $1.25 billion aggregate principal amount of 5.550% senior notes due 2034 and $1.75 billion aggregate principal amount of 5.950% senior notes due 2054 and $800 million aggregate principal amount of 8.000% fixed-to-fixed reset rate junior subordinated notes due 2054 at a price to the public of 99.660%, 99.523%, and 100.000%, respectively, of their face value.

Source: Energy Transfer

These are fixed to fixed notes as shown in the prospectus . The spread however to the 5 year Treasuries was not specified.

We are offering $ aggregate principal amount of our % Fixed-to-Fixed Reset Rate Junior Subordinated Notes due 2054 (the "notes"). The notes will bear interest (i) from and including the original issue date (as defined herein) to, but excluding, May 15, 2029 at the rate of % per annum and (ii) from and including May 15, 2029, during each Reset Period (as defined herein) at a rate per annum equal to the Five-year U.S. Treasury Rate (as defined herein) as of the most recent Reset Interest Determination Date (as defined herein) plus a spread of %, to be reset on each Reset Date (as defined herein), and will mature on May 15, 2054. Interest on the notes will accrue from and including , 2024 and will be payable semi-annually on May 15 and November 15 of each year, beginning on May 15, 2024.

Considering these were locked in on January 11, 2024, the spread is likely close to 4% (8% minus the 5 Year Treasury rate).

So what this means for ET.PR.I pricing is that at the maximum they should yield today is 8%. ET.PR.I at 8% yield would mean a price of $10.55 plus any accrued distributions. But ET.PR.I does not float and offers a fixed high-yield that can create substantial appreciation in case yields crater. As mentioned before these cannot be called either. The new junior notes can be called. The combination of these events makes us stick with our earlier pricing of $11.11. We think these will likely see that price when the large preferred share ETFs like iShares Preferred and Income Securities ETF ( PFF ) rebalance and eventually evict the other ET preferreds.

Verdict

ET.PR.E makes sense for cash parking for those that don't cower at the sight of a K-1. ET.PR.I still remains undervalued though the gap has of course, closed. We might sell for a $11.25 plus price, as we are not in the "yields going lower" camp. At the same time, we think common equities will be a doozy from here, so preferreds should get some extra weightage. One other thing to consider is that there are also other undervalued securities out there. It was just last week that we found a K-1 preferred security yielding 8% , that was rated much higher than ET.PR.I. While that one can be called, a call on that would create more than 50% appreciation, not something we are concerned about.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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