ET - Energy Transfer Stock: 3 Reasons Q3 Earnings Made Me Even More Bullish

2023-11-03 07:00:00 ET

Summary

• Energy Transfer just reported Q3 results.
• ET has long been my top pick in the midstream sector.
• I share three reasons why the Q3 report and earnings call made me even more bullish on ET.

Energy Transfer LP (ET) recently reported Q3 results and discussed them on their earnings call. Three key points jumped out that made me even more bullish on ET:

#1. Leverage Likely Heading Lower With More Credit Rating Upgrades On The Way

First and foremost, it appears that ET management remains focused on not only maintaining a more reasonable level of leverage on the balance sheet but actually improving it further. As they stated in the earnings call:

Our financial position remains strong, and we remain committed to our targeted annual distribution growth rate, which we will continue to balance with leverage reduction...

This implies that ET - despite already approaching the lower end of their 4.0x to 4.5x target leverage range - is still prioritizing bringing it even lower from here, with a later reference on the earnings call to the potential of bringing leverage below 4.0x in the future. What does this mean? A further reduction in ET's investment risk, a further strengthening of the distribution's safety, and likely additional credit rating upgrades. As management stated on the earnings call:

You can already see that we've got the one upgrade from S&P like we've mentioned. And the other two, have us on the positive outlook, and we're going to continue to work with them to get those up to that triple the levels.

While ET has been known for its more aggressive approach to leverage in the past, management appears to be devoted to moving the partnership towards a lower-risk model akin to what peers like Enterprise Products Partners (EPD) have employed with excellence.

#2. Unitholder Capital Returns Likely To Grow Further

Another reason I felt even better about my ET investment after the earnings call was that it appears that - in addition to management doubling down on its 3-5% distribution CAGR guidance - management has unit buybacks increasingly in its crosshairs. When asked about it explicitly on the earnings call, management applied that it wants to deleverage the balance sheet a little bit further first, but then buybacks could certainly be on the table:

the unitholder buyback clearly remains as an option that we'll look at. You're probably going to look at being at the very low end of [our target leverage] range, if not a three on it, the upper three, where you could start seeing us opportunistically starting to buy back units.

When combining its 9.2% distribution yield, 3-5% distribution growth rate, and then the potential for unit repurchases moving forward alongside its low EV/EBITDA and P/DCF multiples relative to its peers, ET appears well positioned to continue delivering double-digit annualized total returns for years to come.

#3. Good News For Lake Charles

Last, but not least, ET had some more positive news on its Lake Charles project. In addition to emphasizing the "significant interest" in the asset from both a demand and equity investor perspective, management also provided the following encouraging update on the regulatory side of the project:

We are in negotiations to finalize our EPC contract, and we are receiving tremendous support from domestic and international customers, community stakeholders, and other interested constituents who are actively encouraging the Department of Energy to approve our pending export authorization application on an expedited basis...We really need to get the DOE to extend the permit. We think they will. As we said, a lot of folks involved behind the scenes trying to make that happen, including other countries, other businesses in other countries, but we're just keeping our head down pushing...we'll see how things go in the next three or four months.

From the sound of things, it appears that there is quite a chorus of support for ET in its attempt to get approval from the Department of Energy. Given the pressing need for the U.S. to boost its standing with its allies around the world right now as well as to bolster the energy security of the world with major energy exporters like Iran, Saudi Arabia, and Russia increasingly at odds with the United States and enjoying support from Communist China, it appears increasingly likely that the DoE will approve ET's request in a fairly timely manner. This will be a nice cash flow catalyst for ET, likely driving distribution growth towards the high end of management's guidance range as well as bringing down the leverage ratio further by increasing EBITDA, thereby accelerating the point in time at which ET may be able to begin buying back units.

Investor Takeaway

While ET is still spending fairly aggressively on growth projects and is also participating in fairly aggressive M&A with its latest acquisition of Crestwood Equity Partners (CEQP), these projects are not coming at the expense of achieving and even exceeding leverage targets and the acquisition of CEQP was an all-stock transaction that was viewed as being credit positive by the ratings agencies.

Not only that, but ET is remaining focused on driving leverage to - and potentially even below - the low end of its target guidance range. Clearly, this is not the old ET, but rather one that has finally "gotten religion" when it comes to fiscal prudence.

As a result, investors can look forward to increasingly sustainable and growing capital returns moving forward, with a distribution that should grow in line with or even faster than inflation and opportunistic unit repurchases on top of that.

Last, but not least, the chances of Lake Charles actually coming to fruition are growing better and better, which will provide an additional tailwind to cash flows and the leverage ratio for ET. As a result, I am increasingly bullish on ET and plan to keep it as one of my largest midstream positions.

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