AY - Energy Transfer Vs. Atlantica Sustainable: Only One 9% Yielder Is A Strong Buy

2023-12-15 12:12:33 ET

Summary

• ET and AY are well-diversified and defensive businesses in the energy infrastructure industry.
• Both also offer well-covered ~9% distribution yields.
• We compare them side-by-side and offer our take on which is the better buy today.

Energy Transfer LP ( ET ) and Atlantica Sustainable Infrastructure plc ( AY ) are two quality infrastructure businesses that offer 9%+ distribution yields that are well covered by cash flow and are backed by solid balance sheets and stable cash-flowing business models. While both offer investors lucrative income streams and both appear to be at least somewhat undervalued, only one of these is a Strong Buy at the moment in our view. In this article, we compare them side-by-side and offer our take on which offers the best overall risk-reward proposition to investors at the moment.

ET Stock Vs. AY Stock: Business Model

AY owns a diverse range of assets, with a focus on renewable energy (~70% of its business) and the rest of the business focused on natural gas generation and regulated utility businesses. The company has assets spread out across the globe, with 40% in North America, 34% in Europe, 18% in South America, and 8% in the rest of the world, giving them broad geographic diversification and enabling them to take advantage of opportunistic regional regulatory incentives.

The company's asset diversification, combined with long-term power purchase agreements, enables it to generate stable cash flows. They use these revenues to service debts, fund new projects, and provide generous distributions to shareholders, creating a virtuous cycle of growth and attractive shareholder returns. Moreover, the weighted average remaining term on their power purchase agreements of approximately 13 years gives them a very stable cash flow profile.

AY's growth strategy focuses on operational efficiencies within its existing portfolio, as well as strategic acquisitions for its growth pipeline. They currently have about 2.1 GW of renewable energy and 6.0 GWh of energy storage assets in development, with a notable 1.1 GW of renewable energy and 4.0 GWh of storage concentrated in North America. This strategic focus is set to capitalize on the opportunities presented by the Inflation Reduction Act.

During its latest quarterly earnings call, AY's management emphasized the high-growth outlook for the renewable energy sector, buoyed by robust demand and a supportive regulatory and financial landscape. They conveyed confidence in their ability to incorporate their higher cost of capital into new acquisitions without compromising profitability, viewing the current economic climate as advantageous for well-established businesses with strong financials and a history of success.

Management also highlighted the lower-risk profile of AY's business model, marked by its simple and prudent financing structures, predominantly comprised of project-level debt that is paid down by the time that power purchase agreements on those projects expire. Moreover, the company's revenue streams are mostly contracted or regulated and have built-in inflation escalators, providing cash flow stability and a defensive nature to the business model.

Despite AY's current moderate growth rate amid the ongoing strategic review, the long-term outlook for the business remains positive. Moreover, Atlantica's largest shareholder, Algonquin Power & Utilities Corp. ( AQN ), has recently indicated its confidence in its ability to divest its renewable assets at attractive valuations in 2024, including potentially its stake in AY. This presents a prospective catalyst for AY stock, and - given that AY is also in the middle of its own strategic review - we think that a full acquisition of AY is quite possible in conjunction with AQN's renewable platform sale.

ET is a leading energy midstream company that has a vast network of midstream infrastructure assets throughout the United States. The size of this network and its access to various important markets provide the company with a significant strategic advantage. Around 90% of ET's EBITDA comes from contracted assets, which makes it well-insulated from commodity price volatility, with only 10% of EBITDA exposed to such fluctuations. ET has achieved strategic growth through accretive acquisitions and organic expansion projects. Recently, this was demonstrated through the company's acquisitions of Lotus Midstream and Crestwood Equity Partners LP ( CEQP ). Moreover, ET invests nearly $2 billion annually in organic growth projects to drive further growth for the business. As a result, ET enjoys an attractive combination of stable cash flows with considerable long-term visibility as well as numerous growth opportunities.

ET Stock Vs. AY Stock: Balance Sheet

Despite having a history of maintaining high leverage ratios that have put their investment grade credit rating at risk, ET has recently adopted a more cautious approach towards managing their leverage. They have taken steps to pay off billions of dollars' worth of debt, which has resulted in a reduction of their leverage ratio to the lower end of their targeted range of 4.0x to 4.5x. Moreover, they have expressed their intention to reduce it below 4.0x in a deliberate effort to derisk their balance sheet further and ensure that they can maintain and grow their distribution over the long term. Currently holding a BBB credit rating, ET's increasingly conservative approach to their balance sheet could lead to an upgrade to BBB+, provided they continue on their present course.

Meanwhile, AY also has a solid balance sheet with a healthy liquidity position and a prudent approach to debt management. As of September 30, 2023, AY reported strong corporate liquidity of approximately $441.1 million, consisting of $48.0 million in corporate cash and $393.1 million in available revolving credit facilities. The corporate debt profile is conservative, with an average maturity of 3.4 years and no significant debt maturities in the short term, indicating a well-structured debt repayment timeline.

AY's total corporate debt is just over $1 billion, with a substantial portion being fixed or hedged. Specifically, the company has managed to fix or hedge about 96% of its corporate debt, ensuring stability against interest rate volatility. Additionally, 92% of its project debt is fixed rate, further reducing interest rate risk. Moreover, AY's net corporate debt to CAFD ratio is 3.4x, reflecting a solid balance sheet further boosted by the company's scheduled debt reduction of approximately $1.9 billion over the next five years as it amortizes project-level debt.

ET Stock Vs. AY Stock: Distribution Outlook

ET's management has guided for a 3-5% distribution CAGR for the foreseeable future, and analysts seem to believe this narrative, forecasting a 4.1% distribution CAGR through 2026. With a 1.94x coverage ratio forecast for 2023, a solid balance sheet, and solid growth potential, there is no reason to believe that this will not be attainable for them.

AY, meanwhile, is not currently providing distribution growth guidance due to their ongoing strategic review, and ultimately, the outcome of that review will have a major impact on what their distribution's trajectory looks like moving forward. That said, their distribution is expected to be covered 1.13x by CAFD this year, and analysts expect it to grow at a 2.5% CAGR through 2026.

ET Stock Vs. AY Stock: Risks

Both businesses have relatively low-risk profiles, with ET's main risk coming from the potential for regulations to negatively impact its business (including the current uncertainty surrounding its Lake Charles project) and the potential for the energy transition to cause demand to plummet for fossil fuels. That being said, the past few years have illustrated how important fossil fuels remain as a strategic energy resource for the developed world and the potential shortcomings of renewable energy as a complete replacement for fossil fuels. As a result, we think that ET's long-term risk profile remains relatively low.

AY, meanwhile, has a very stable business model and balance sheet that should keep its risk profile fairly low. Its main risks remain its access to capital (time will tell where this ends up as the markets are currently trying to figure out where interest rates will settle long-term) as well as the outcome of its strategic review. Another risk is the uncertainty of just how big of a role renewable energy will play in the future global economy. While we are not believers in the thesis that renewables will completely replace fossil fuels, we do believe that it is clear that renewable energy is here to stay and has a meaningful growth runway ahead of it.

ET Stock Vs. AY Stock: Valuation

ET and AY offer very attractive distribution yields right now, with ET offering investors a 9.3% NTM yield and AY offering investors an 8.6% NTM yield. On an EV/EBITDA basis, ET trades at a 7.31x multiple compared to its five-year average of 8.10x, while AY trades at a 9.19x multiple compared to its five-year average of 9.78x, so both appear roughly equally undervalued relative to their historical averages, and both offer similar distribution yields.

However, one important distinction is that AY is currently undergoing a strategic review and could very well be acquired next year, which would provide it with a strong potential near-term catalyst. It is also quite possible that AY may bring on a sponsor through its strategic review and - if interest rates do indeed continue to decline in 2024 as the Fed pivots towards cuts - it could very possibly see its growth accelerate to a mid to high single digits CAGR. As a result, we think that while both are currently trading at similar valuation discounts, AY has greater near-term catalysts and long-term growth potential.

ET Stock Vs. AY Stock: Investor Takeaway

Both businesses have well-diversified portfolios of assets, defensive, stable cash-flowing business models, solid balance sheets, very attractive and well-covered distributions, and trade at meaningful discounts. Which one an investor prefers will largely hinge on how that investor views the energy landscape shaking out. For those who think that hydrocarbons will remain dominant in the energy landscape and that renewable energy is little more than a pipedream, ET is the obvious choice. For those who believe renewable energy will continue to grow market share rapidly for decades to come and that fossil fuels are nearing terminal decline, AY is the obvious choice. In our view, we think that both forms of energy will play a crucial role in the world's future economy and therefore, think that there is room for both ET and AY in an income-focused portfolio.

However, given that AY has greater long-term growth potential and a more powerful near-term potential catalyst, we think that AY is a Strong Buy right now and ET is just a Buy.

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