ET - Energy Transfer: Stay The Course And Load Up On Steep Pullbacks

2023-09-19 12:00:37 ET

Summary

• Energy Transfer LP unitholders have seen a remarkable revival in their fortunes as the company rallied significantly over the past few weeks.
• The recent acquisition of Crestwood is expected to expand Energy Transfer's market leadership and bolster its distributable cash flows.
• Energy Transfer's valuation remains attractive, and its solid distribution yield offers holders a defensive play in a leading midstream company.
• Despite that, I assessed that near-term caution is warranted, given its recent sharp recovery. Buying the next steep pullback could help improve risk/reward markedly.

Leading midstream player Energy Transfer LP's ( ET ) unitholders have recently enjoyed a remarkable revival in its fortunes as ET re-tested its January 2023 highs.

I updated holders in my previous article in July, upgrading ET to Strong Buy on the back of my bullish thesis on the sector. Given ET's attractive valuation to peers (assigned a "B" valuation grade by Seeking Alpha Quant), I have confidence Energy Transfer is well-positioned to benefit from the recovery. Bolstered by its industry-leading profitability (assigned "A-" profitability grade by Seeking Alpha Quant), value and income investors looking for a defensive energy play have likely added more exposure to ET.

As such, ET has significantly outperformed the S&P 500 (SP500) on a total return basis since my update. However, I also noted that its upward momentum has stalled as it re-tested its January 2023 highs, suggesting near-term caution is warranted.

Despite that, it underscores the market's confidence in its recent acquisition of Crestwood ( CEQP ), which is expected to expand its market leadership by gaining exposure into the Powder River basin. The $7.1B all-equity deal is expected to be " immediately accretive " to Energy Transfer's distributable cash flow, or DCF, upon closing. As such, Energy Transfer should maintain its ability to keep its adjusted EBITDA leverage ratio in the 4-4.5x range.

Crestwood's confidence in accepting the all-equity deal supports my thesis that ET is attractively valued. Accordingly, management updated holders it believes " in the potential for Energy Transfer's unit price to increase over time, driven by the execution of the business plan." The LP also accentuated the potential of upward re-rating in ET's valuation "toward a trading multiple of above 9x firm value to EBITDA, in line with peer groups."

Accordingly, ET last traded at a forward EBITDA of 7.8x, well below its 10Y average of 10.8x. Moreover, its attractive forward distribution yield of 9.3% offers unitholders a solid defensive profile against underlying market volatility. As such, while I expect some near-term downside, I also expect dip-buyers to return strongly to underpin its attractive valuations.

Analysts' estimates suggest Energy Transfer's DCF is expected to inflect back into growth in FY23, up 1.5%. It's sufficient to cover its distributions, supporting income investors looking for predictable income streams while leveraging Energy Transfer's 90% fee-based EBITDA composition. Analysts' estimates (ex-Crestwood) also suggest a re-acceleration in Energy Transfer's adjusted EBITDA growth for FY23, up 1.5% after last year's 0.4% uptick. It's slightly above the midpoint outlook of Energy Transfer's adjusted EBITDA guidance range of between $13.1B and $13.4B.

Therefore, I assessed that the market is likely pricing in a further growth uptick in Energy Transfer's underlying business as it looks to close its recent acquisition.

Notwithstanding Energy Transfer's fee-based adjusted EBITDA predictability, ET's price action remains relatively volatile. As seen above, ET experienced sharp upswings/downswings over the past year. Hence, I assessed that investors looking for a more attractive risk/reward proposition consider buying more aggressively when ET falls closer to its critical moving average support levels (blue line).

With ET's upward momentum seemingly stalling as it re-tested its January 2023 highs, I gleaned near-term caution is apt. As such, I move back to the sidelines at the current levels as we assess another opportunity to move back into ET at more attractive support zones.

Rating: Downgraded to Neutral.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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