UMI - Energy Transfer: Yet Significantly Undervalued

Summary

• Natural gas prices in the United States jumped to more than $9/MMBtu due to increased natural gas demand for U.S. LNG exports and high temperatures in the United States.
• I expect that in the third quarter of 2022, the effect of high natural gas prices on Energy Transfer's revenue to be more significant than in 2Q 2022.
• In September 2022, oil and gas production in Permian Basin is expected to increase to 5408 thousand barrels per day and 20584 MMBtu per day, respectively.
• Energy Transfer stock is worth more than $20 per share.

Energy Transfer LP ( ET ) stock price increased 15% during the last month. Meanwhile, natural gas prices in the United States increased from $5.4/MMBtu on 30 June to $9.2/MMBtu on 23 August 2022. Furthermore, the company reported strong financial results for the second quarter of 2022. I expect the natural gas market to be strong for the rest of 2H 2022. Also, due to ET's recent developments, the company is able to benefit from the market condition. My valuation shows that the stock is a strong buy and is worth more than $20 per share.

Energy Transfer 2Q 2022 highlights

In its 2Q 2022 financial result, ET reported revenues of $25.9 billion, compared with 2Q 2021 revenues of $15.1 billion, up 72%. The company's cost of products sold increased from $15.5 billion in 2Q 2021 to $21.5 billion in 2Q 2022. ET reported total costs and expenses of $23.9 billion, up 76% YoY. ET reported 2Q 2022 net income attributable to partners of $1.33 billion, up $700 million YoY. The company's net income per common unit increased from 20 cents per diluted unit in 2Q 2021 to 39 cents per diluted unit in 2Q 2022. Energy Transfer reported a consolidated adjusted EBITDA of $3.2 billion in the second quarter of 2022, up $612 million YoY.

It is worth noting that in the second quarter of 2022, ET's transportation volumes increased across all of its segments. Also, during 2Q 2022, the company achieved record processing volumes in the Permian Basin. "In support of this increased activity. The Partnership is currently constructing two new cryogenic processing plants," the company announced . Furthermore, in the second quarter of 2022, ET reported record total NGL transportation and fractionation volumes. Due to placing the TED Collins link into service in April 2022, ET's crude oil export volumes increased in 2Q 2022.

The market outlook

Increased NGL/ gas prices, and the acquisition of the Enable Oklahoma Intrastate Transmission system, combined with expanded NGL pipeline and export activities, were the main drivers of ET's strong financial performance in the second quarter of 2022. Figure 1 shows that natural gas prices in the United States increased from $5.4/MMBtu on 30 June 2022 to $9.2/MMBtu on 23 August 2022, up 70%. Due to increased natural gas demand for US LNG exports driven by the Russia-Ukraine war, combined with high temperatures in the United States, which increased demand for air conditioners, U.S. natural gas futures jumped to these levels for the first time since July 2008. Thus, I expect that in the third quarter of 2022, the effect of high natural gas prices on ET's revenue, EBITDA, and net income to be more significant than in 2Q 2022.

According to U.S. Energy Information Administration ((EIA)), the Permian Basin is the second-largest shale gas-producing region in the United States, which produced, on average, 34.8 Bcf/d of marketed natural gas in 2021. Figure 2 shows that 17% of ET's adjusted EBITDA belongs to the crude oil segment, which has significant connectivity to the Permian, Bakken, and Midcon Basins. According to EIA's recent report , oil production in Permian Basin is expected to increase from 5329 thousand barrels per day in August 2022 to 5408 thousand barrels per day in September 2022. It is worth noting that in June 2022, production in Permian Basin was 5232 thousand barrels per day. Also, oil production in the Bakken Basin is expected to increase from 1136 thousand barrels per day in August 2022 to 1157 thousand barrels per day in September 2022 (see Figure 3).

Moreover, Figure 2 shows that 28% of ET's adjusted EBITDA in 1Q 2022 belongs to the midstream (natural gas) segment, which has strong connectivity to the company's operations in Permian, Eagle Ford, Anadarko, and Marcellus/Utica Basins. According to Figure 3, gas production in the Anadarko region is expected to remain almost the same from August to September 2022. However, in September 2022, gas production in Eagle Ford and Permian is expected to increase by 116 and 167 million cubic feet per day, respectively. The Partnership expects 2022 adjusted EBITDA of between $12.6 billion to $12.8 billion (previously $12.2 billion to $12.8 billion). Due to increased natural gas prices, increased demand for ET's products in the United States, and significantly higher market share of worldwide NGL exports, the company's expectation about its full-year 2022 adjusted EBITDA is rational.

Figure 1 - Natural gas price in the U.S.

Figure 2 - ET's adjusted EBITDA by segment in 2Q 2022

Figure 3 - Oil and gas production by region in August and September 2022

Performance outlook

Since the last quarter, Energy Transfer's net debt decreased to now sit at $48.9 billion, which is beneath its previous level of $50.3 billion in the first quarter of 2022 but still above its amount of $47.1 billion in Q2 2021. When looking ahead to the rest of 2022, the company's net debt may decrease more for the sake of acquisitions and unit buybacks. Compared with the second quarter of 2021, ET's total equity increased by 14% to $41.2 billion in Q2 2022 from $36 billion in Q2 2021.

Notwithstanding a 68% drop in its cash balance from $1.1 billion in the last quarter, its $353 million cash in Q2 2022 is still above its amount of $282 million in the same quarter last year. Thus, ET's capital structure prospects a healthy position and enables the company to consider debt and equity financings (see Figure 4).

Figure 4 - ET's capital structure (in millions)

After seeing a strong start to 2022, which is indicated in a 36% increase in the company's operating cash flow in the first quarter of 2022, $2.3 billion, compared with its amount of $1.7 billion at the end of 2021, their operating cash flow remained almost unchanged around $2.3 billion in Q2 2022. Furthermore, Energy Transfer's capital expenditure declined by around 34% to $706 million in Q2 2022 versus its previous amount of $1 billion in the first quarter of 2022. When all was said and done, the company ultimately generated a massive $1.6 billion of free cash flow during this quarter, which could lead to scope for higher distributions. ET's free cash flow is well above its year-to-year amount of $898 million in Q2 2021 (see Figure 5).

Figure 5 - ET's cash structure (in millions)

Stock valuation

After watching Energy Transfer's well-performed cash and capital structure, we observed that the company has been able to generate a good amount of free cash flow so far. If ET management decides to direct the free cash flow to pay back its net debt, it would reduce its net debt amount by the end of 2022. Based on the predicted net debt and adjusted EBITDA for 2022, I evaluated the stock's fair price. The company increased its Adjusted EBITDA guidance for the second time, which shows a strong outlook. In Table 1, I considered the lower and the upper end of ET's adjusted EBITDA guidance for 2022, which are $12.6 billion and $12.6 billion, respectively. According to such inputs, the stock's fair value would be around $20 (see Table 1).

Table 1 - ET stock valuation

Summary

Analysis of Energy Transfer's financial performance implies that the company has been doing great in 2022. ET's free cash flow is well above its year-to-year amount of $898 million in Q2 2021. Also, ET's capital structure prospects a healthy position and enables the company to consider debt and equity financings. My valuation shows that the stock is worth more than $20 per share, which means that the stock is very opportunistic at its current prices. Due to the natural gas price outlook and natural gas demand outlook in the United States and abroad, the market condition is in favor of Energy Transfer to benefit its shareholders.

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