Summary
- Energy Transfer and Western Midstream are among the most attractively priced high-yield investment-grade midstream businesses.
- While WES has a lower leverage ratio and a higher free cash flow yield, ET is bigger, more diversified, and offers a higher distribution yield.
- We compare them side by side after reporting Q4 results and offer our take on which is a better buy at the moment.
Energy Transfer (ET) and Western Midstream (WES) are among the most attractively priced high-yield investment grade midstream businesses. While WES has a lower leverage ratio and a higher free cash flow yield, ET is bigger, more diversified, and offers a higher distribution yield.
In this article, we compare them side by side after reporting Q4 results and offer our take on which is a better buy at the moment.
Energy Transfer Vs. Western Midstream: Q4 Results
Both businesses reported solid Q4 results. WES's report was highlighted by:
- It generated full-year Adjusted EBITDA of $2.128 billion, well within its Adjusted EBITDA guidance range of $2.125 billion to $2.225 billion.
- It generated full-year Free cash flow of $1.268 billion, also within its Free cash flow guidance range of $1.250 billion to $1.350 billion.
- WES announced that it expects to pay out an enhanced distribution of $0.36 along with the first quarter base distribution of $0.50 per unit. In conjunction with the expectation of a $2 annualized base distribution, this equates to an 8.6% annualized distribution yield alongside the partnership's very aggressive unit repurchase program.
- WES also expects to generate nearly as much free cash flow in 2023 as it did in 2022, which - combined with its reduced unit count - should lead to similar free cash flow per unit in 2023 relative to 2022 through which it expects to repurchase more units, reduce debt even further, and continue to pay a very attractive distribution.
ET's Q4 results were highlighted by:
- Q4 records for NGL fractionation and transportation volumes
- Adjusted EBITDA soaring from $2.81 billion in Q4 2021 to $3.44 billion in Q4 2022.
- Q4 DCF soaring to $1.91 billion from $1.6 billion in Q4 2021.
- 2023 guidance indicates flattish adjusted EBITDA year-over-year, as volume growth is expected on its existing assets along with additional projects coming online and continued growth in its NGL pipeline, fractionation, and export businesses, but lower commodity prices and the drop-off of one-time tailwinds in 2022 will offset much of this benefit.
ET also made clear that its top capital allocation priorities moving forward will be continuing to pay down debt in pursuit of a credit rating upgrade and investing in attractive growth projects. It seemed to imply that no more distribution hikes are likely in 2023, but that they will likely increase it on an annual basis moving forward.
Meanwhile, management also seemed to imply that it is strongly considering issuing a C-Corp currency, stating on the earnings call:
We do have a team that's working on that [a C-Corp currency]. I guess the way I would tell you is that we are spending quite a bit of time on evaluating that. And we feel pretty good about probably 2023. We're going to be a little bit careful about putting in guidance out there right now. But it's something that we still think makes a lot of sense and are spending a lot of time. But can't really guide you any closer than that.
If implemented, this would represent a significant development for ET, as it would allow the company to offer the best of both worlds to investors. Existing long-term unitholders, such as the founder and Executive Chairman Kelcy Warren, would be able to retain their K-1 issuing units and continue to benefit from the associated tax advantages. At the same time, the move would make ET units accessible to investors who have previously been deterred from investing in the partnership.
Energy Transfer Vs. Western Midstream: Business Model
Energy Transfer is a major player in the midstream sector, enjoying access to all major U.S. supply basins through its interstate and storage business, which allows it to take advantage of significant economies of scale. In contrast, WES has an enterprise value almost six times smaller than ET's. Along with its size, ET boasts a highly diversified portfolio of assets, including natural gas, NGLs, crude, refined products, storage, fractionator, terminal, processing, and treating assets. This diversification is further evidenced by the fact that no more than 30% of its adjusted EBITDA comes from any one of its five business segments, ensuring that it is not reliant on any single commodity or business segment for revenue.
The vast majority of ET's adjusted EBITDA is fee-based, with only a small percentage (no more than 12.5%) being sensitive to commodity prices, providing significant cash flow stability. Management has taken steps to reduce the company's debt and bring online its extensive growth project pipeline, resulting in a reduction of capital expenditures and a significant increase in free cash flow after distributions.
WES, on the other hand, has a more focused geographic and commodity reach, with its operations mainly providing gathering, processing, and transportation services for natural gas and natural gas liquids in Texas, New Mexico, the Rocky Mountains, and North-central Pennsylvania.
Despite this, WES shares a common advantage with ET in that most of its EBITDA is derived from fee-based contracts, reducing its exposure to commodity prices. In fact, over 80% of its natural gas throughput, 96% of its crude oil throughput, and 100% of its water cash flows are tied to these contracts. WES also benefits from a lengthy contract maturity profile, which further insulates it from industry and commodity price swings. Its primary counterparties are Occidental Petroleum ( OXY ), which is backed by Warren Buffett, and investment-grade ConocoPhillips ( COP ), both of which are high-quality energy companies.
Overall, both of these companies have excellent business models, but ET holds an advantage due to its larger size and scale, which should provide more long-term investment opportunities for growth as well as lower exposure risk.
Energy Transfer Vs. Western Midstream: Balance Sheet
In this area, ET comes out on top because WES is only considered investment grade by one of the two primary credit rating agencies, while ET has received investment-grade ratings from both Moody's and S&P. ET is also looking at a potential upgrade to BBB in the not-too-distant future with a positive outlook on their credit rating and a stated ongoing dedication to continued deleveraging.
That said, WES's year-end leverage ratio of 3.1x was a major positive as it was not only well below their year-end 2022 leverage target of 3.4x, but it was even below their year-end 2023 leverage target of 3.2x while only being slightly above their year-end 2024 leverage target of 3.0x. This should provide them with meaningful financial flexibility as they head into 2023 and will enable them to return cash to unitholders more aggressively via buybacks and enhanced distributions.
Both businesses look to be in very strong financial shape.
Energy Transfer Vs. Western Midstream: Distribution Outlook
Moving forward, both current distribution levels look very safe and very well covered by distributable cash flow alongside sound balance sheets. That said, ET's management has signaled an intent to look at growing its quarterly distribution on an annual basis moving forward whereas WES seems to favor the approach of maintaining its $2 annual distribution and supplementing it with opportunistic unit repurchases and an end-of-year enhanced distribution whenever possible based on current leverage levels relative to the leverage target.
Energy Transfer Vs. Western Midstream: Valuation
Both businesses also look very attractively priced when compared to sector peers as well as their own histories. Here is a side-by-side comparison of them:
ET | WES | |
EV/EBITDA | 7.78x | 7.81x |
EV/EBITDA (5-Yr Avg) | 8.74x | 9.25x |
P/2023 DCF | 4.80x | 5.68x |
Distribution Yield | 9.5% | 7.6% |
Overall, ET appears to have the clear edge in terms of distribution yield and P/2023 DCF. However, it is worth keeping in mind that WES looks slightly cheaper compared to its historical average EV/EBITDA than ET is relative to its own historical average EV/EBITDA and their current EV/EBITDA multiples are virtually identical. Additionally, WES has a higher cumulative capital return yield given that it is buying back units at a pretty aggressive clip and its enhanced distribution is not included in the above distribution yield.
Investor Takeaway
At High Yield Investor, we really like and own both of these midstream businesses. However, we currently have a larger position in ET due to its superior credit rating, better diversified asset portfolio, greater potential for organic growth, higher regular distribution yield, and slightly cheaper EV/EBITDA and P/DCF valuation multiples. On the other hand, WES is an attractive option for investors seeking an aggressive approach to unit repurchases, particularly given the current low prices of its units, which sets it apart from other midstream businesses. For more information, you can read our recent exclusive interview with WES here and our full investment thesis here . You can also read our full ET investment thesis here and our exclusive interview with ET here . Note that both businesses issue K1 tax forms, so keep that in mind before purchasing the units of either one.
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Better Buy After Q4 Results: Energy Transfer Or Western Midstream