ET - Energy Transfer Vs. Plains All American: Only One Is A Buy

2024-01-14 12:00:00 ET

Summary

• Both Energy Transfer and Plains All American Pipeline have strengthened their positions and improved their credit ratings since the energy industry collapse in 2020.
• Both have also seen their unit prices soar over that period of time, delivering market-crushing performance in the process.
• We compare them side-by-side and offer our take on which one we would buy today.

Both Energy Transfer ( ET ) and Plains All American Pipeline ( PAA )( PAGP ) are high-yield investment-grade midstream MLPs ( AMLP ) that have taken a very similar path in recent years. Both had BBB- credit ratings and had invested aggressively in growth when COVID-19 broke out and the energy industry nearly collapsed due to plunging energy prices. As a result, both MLPs slashed their distributions and capital expenditures while putting maximum focus on paying down their debt.

These efforts have paid off as since then their credit ratings have been bolstered, their balance sheets have been deleveraged, and their distributions are once again on the rise. Most importantly, their unit prices have soared, resulting in outstanding total returns for unitholders who - like us - bought in late 2020:

While the businesses have definitely strengthened their positions over the past few years, the sheer amount of outperformance that they have generated has diminished the attractiveness of their valuations. In this article, we will compare them side-by-side and offer our take on which one remains a buy today.

ET Stock Vs. PAA Stock: Business Models

ET's main advantage over PAA is its much better-diversified energy infrastructure portfolio. PAA is primarily focused on oil-related energy infrastructure based in the Permian Basin, though it does derive ~17% of its adjusted EBITDA from its Canadian NGL business. Moreover, while it is largely a concentrated bet on the Permian, PAA's assets in the region are considered to be high quality. The business is also fully integrated, giving it some competitive advantages. Moreover, management feels strongly that - after selling off most of its non-core assets in recent years - its remaining assets are worth holding for the long term and would only part ways with them if they received a compelling offer.

ET, meanwhile, generates EBITDA from a diversified group of five business segments:

1. Crude Oil (20%)
2. NGL & Refined Products (30%)
3. Midstream (Gathering & Processing) (18%)
4. Natural Gas Interstate & Intrastate Transportation & Storage (21%)
5. Sunoco ( SUN ), USA Compression Partners ( USAC ) & Other Investments (11%)

This comprehensive network of energy infrastructure assets gives it competitive advantages that stem from its economies of scale, access to numerous key basins and NGL export facilities, and a fully integrated business model.

Moreover, its cash flow profile is remarkably stable due to its broad diversification as well as the fact that it generates ~90% of its EBITDA from contracted assets and only 10% of its EBITDA is sensitive to commodity price volatility. ET has also proven to be a leading industry consolidator and has done a good job recently of purchasing businesses in an accretive and leverage-neutral manner, the latest of which is the purchase of Crestwood Equity Partners ( CEQP ).

Another area in which ET differs from PAA is that - while PAA is using its surplus cash flow to continue paying down debt, buy back stock, and invest in a few high-yielding organic growth projects - ET is continuing to invest aggressively in growth projects such as its Lake Charles project. While Lake Charles has been plagued by regulatory issues, recent news on the project is quite positive and indicates that there are plenty of customers and joint investors who are interested in making this project a success and putting pressure on key U.S. regulatory agencies to authorize the project to reach completion.

Overall, while we think PAA's business model is strong - especially for those bullish on Permian oil production - we prefer ET's overall as it has stronger long-term growth potential and is also much better diversified, resulting in better cash flow stability and a longer likely period of viability as the economy continues to transition increasingly away from fossil fuels.

ET Stock Vs. PAA Stock: Balance Sheets

Both businesses have strong balance sheets after working hard to deleverage in recent years and they each have earned upgrades from S&P that have brought their ratings up from BBB- to BBB.

Both also anticipate exiting 2023 with their leverage ratios at the low end or even below their target ranges: ET's will likely be at 4.0x or even lower and PAA's will likely be at 3.5x or even lower.

ET has emphasized that it feels confident keeping its leverage ratio at this level for the foreseeable future and it will likely move lower over time as new EBITDA comes online via its fairly aggressive growth projects as well as through its recently announced preferred equity redemption program (though this will temporarily increase its leverage since preferreds only count as 50% debt according to the rating agencies whereas the debt they are raising to execute these redemptions is counted as full debt).

PAA, meanwhile, could very well see its leverage ratio continue to move lower and/or shift more capital toward special distributions and/or unit buybacks given that it has much fewer opportunities for growth investments. PAA has also mentioned that it could possibly redeem its preferred equity as well in the future.

Overall, we view both balance sheets as being roughly equal. PAA's leverage ratio is lower, but ET is moving to redeem the lion's share of its preferred equity, which should greatly improve its capital stack, and also generates more cash flow after distributions than PAA, giving it greater flexibility to pay down debt should it choose to take that route. Its more diversified business model and greater cash flow stability relative to PAA also mean that it can handle more leverage than PAA can.

ET Stock Vs. PAA Stock: Distribution Outlooks

This is one area where - for the near term at least - PAA beats ET. ET only anticipates growing its distribution in the 3-5% annualized range for the foreseeable future as it focuses on redeeming its preferred units and investing in long-term growth.

In contrast, PAA is poised to continue growing its distribution at a double-digit CAGR for the next several years as it has much fewer growth investment opportunities and is not currently moving to redeem its preferred units.

That being said, it is important to keep in mind that ET's payout ratio is only slightly over 50% on a DCF basis and appears likely to remain in that range for years to come whereas PAA is actively working to reduce its payout ratio to 1.6x. As a result, ET has a safer distribution and greater potential for long-term distribution growth.

ET Stock Vs. PAA Stock: Valuations

When it comes to valuation, ET looks considerably cheaper than PAA on an EV/EBITDA basis. In addition to trading at a nearly 2 turns cheaper EV/EBITDA than PAA, ET also trades at a steep premium to its five-year average EV/EBITDA whereas PAA trades at a slight premium to its five-year average EV/EBITDA. Moreover, ET's distribution yield is higher than PAA's and its P/DCF ratio is lower than PAA's.

The only areas where PAA beats ET are in the non-objective/projected statistics: its expected distribution and DCF per unit CAGR through 2027. However, the DCF per unit CAGR is largely based on expectations that Permian production will grow meaningfully in the coming years, and ET could easily match or exceed this if its Lake Charles project comes to fruition and/or once it completes its preferred unit redemptions as well as potentially implements come common unit buybacks. Moreover, longer term we expect ET's DCF and distribution per unit CAGRs to outpace PAA's as it is investing much more aggressively in long-term growth projects and is retaining more cash flow.

Overall, we think that ET offers better value to investors at current valuations.

ET Stock Vs. PAA Stock: Investor Takeaway

While PAA is definitely the more exciting distribution growth investment at the moment, we think that ET offers investors a more attractive risk-reward proposition given its overall superior business model and more attractive valuation. As a result, we rate ET a Buy and PAA a Hold at their current respective valuations.

Note that ET and PAA both issue K-1 tax forms whereas PAGP (PAA's economic equivalent) issues a 1099 tax form. Please do your own tax due diligence before investing.

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