2023-10-27 00:49:04 ET
Summary
- The NGL & Refined Product division is now the largest contributor of group EBITDA, and it looks poised to stay that way, given some of the encouraging developments there.
- We are particularly enthused by the dynamics in the ethane and propane export markets.
- Management's intention to step-up its CAPEX run rate should not be seen in negative light, given the improving FCF capabilities of the asset base.
- Meanwhile the leverage position is in a better state, and we may soon see unit buybacks.
- Even though we like the ET story, we question the merits of commencing a long position now.
Context Of The Article
The stock of Energy Transfer LP ( ET ), an operator of a vast and diversified pool of energy assets, has a number of sub-plots working for and against it. In this article, we’ll highlight two important sub-plots, and then close with some thoughts on why the stock may not necessarily be a rewarding BUY at this stage.
ET’s NGL/Refined Product Division Will Only Grow In Stature
Energy Transfer’s EBITDA comes from 8 different sources, but the segment we’re most enthused by is the segment that focuses on the transportation of NGL (Natural Gas Liquids) and Refined Products. Last year, it was the second largest contributor to annual group EBITDA, but this year (as of H1) it has become the top contributor, accounting for 27% of ET’s total EBITDA.
In H1, this segment saw impressive EBITDA YoY growth of 21%, and there’s a good chance the momentum lingers. Transportation volumes continue to be resilient, and NGL inventory timing effects to the tune of +$51m should also leave a positive mark in H2.
Secondly, the surge in the export of ethane propane, and other NGLs from America should not be underestimated. Domestic propane inventories may be at record highs, but what’s key to note is that close to 60% of this gets exported. This year we’ve seen a few OPEC+ producers resort to production cuts, and that too has limited the supply of propane inventories in the international market (besides being a byproduct of natural gas production, propane is also sourced during crude oil refining). As a result, US propane exports have gone through the roof (see image) and could stay elevated all through this year.
The trend of ethane exports is another shining light and should reflect well on this division’s numbers. Note that in H1, ethane exports out of the country averaged 493,000 barrels a day, translating to solid growth of 22%, but as recently as September, ethane exports were hitting levels of over 500,000 barrels a day. We don’t believe this is just short-term euphoria either; the EIA believes the country could continue to export at this 500k rate through the end of FY24.
Readers would also be interested to know that ET management recently stated that they are in discussions to lock in close to 30-36% of the aggregate ethane volumes that will come into the system over the next 3-4 years.
It's also rather well known that ET is relatively well insulated from the capricious nature of commodity prices, as its contracts are predominantly long-term and fee-based, but what’s also key is the dominance of take-or-pay transportation contracts, particularly in this segment. Currently, ET is benefitting from some very strong volumes, but even if volumes were to slow for some reason (which is not the base case), these contracts demand that payments be made to ET regardless of whether a fixed volume is transported.
ET’s Financing Policies And Capital Management Are In A Better Place
To flourish and build scale in this business, management needs to exercise good judgment with capital and leverage, and even though the jury is still out, it's fair to say that things are better than where they were a few years back.
At the start of last year, Energy Transfer had intended to only deploy $1.575bn-$1.8bn by way of growth CAPEX, but primarily on account of the Lotus Midstream acquisition this year, further investments will also be made there, pushing up the overall figure. All in all, growth CAPEX for the year will likely come in within a higher range of $1.9bn-$2.1bn , and the long-term plan is for the company to push the CAPEX runrate closer to $3bn p.a.
We understand that this likely ramp-up in CAPEX won't please all stakeholders of ET, but we feel investors should be less skeptical in questioning the capital allocation and financing decisions of the management, particularly in light of some of the improvements engendered in recent years.
Firstly, we bring to attention the manner in which ET has been financing its growing asset base in recent years. A couple of years back, around 53% of the asset base was being financed by debt; however, this has consistently crept down since then and currently stands at around 45%.
It also helps that ET's assets are now generating some useful FCF (which in turn puts less pressure on the need for external funds), something it was barely managing to do during the pre-pandemic era.
Admittedly ET still has a hefty sum of $48.1bn of total debt on its balance sheet, and some of you may be wondering how best placed the company looks in a higher interest rate environment, but do note that as of H1-23, only 10% of its total debt consisted of floating rate debt.
Note that as a function of EBITDA, ET’s target debt level range is 4-4.5x , and hitting the lower end of that range, is something they intend to do very soon. If that happens, investors have another added reason to feel more encouraged as you could see the company recommence its unit buyback activities, something which has gone dormant since Q4-21 . For context note that the company still has around $880m of funds that could be authorized towards this endeavor.
Why The ET Stock Isn’t A Compelling Buy Now
Even though we can find plenty of reasons to appreciate the well-rounded business of Energy Transfer, we are not necessarily convinced that this is the right time to kickstart a long position in the stock per se. Here’s why.
Let’s first look at ET’s long-term price imprints on the monthly chart. Since dropping to the pandemic lows of sub $4, the stock has done well to make up lost ground by trending up in the shape of a rising wedge pattern. However, the issue with a rising wedge pattern is that it typically signs the increasing possibility of a reversal after an uptrend.
Now, an inverted V-shaped reversal in the price action may not necessarily come to fruition, but we do think the possibility of sideways movement has increased, rather than another strong move higher.
We say this because firstly, resorted to any major pullbacks since the start of 2022, rather there’s just been a pause for a brief while followed by another upward leg. Secondly, also consider that the stock has now revisited the old congestion zone which coalesced from Q2-2016 until Q3-2019. During this period ET had just chopped around within this zone lacking direction; don’t be surprised to see the stock take another breather here.
Then, prima facie, relative to most other alternatives a +9% yield is something to behold, but this should also be contextualized relative to what unitholders have typically received. Even though the recent distribution growth came in at an impressive rate of 18% YoY, the uptrend in the stock has been such, that the current distribution yield falls short of the 4-year average by around 120bps .
You also want to be getting into a stock when forward valuations are well below the long-term average, but with ET that is quite the opposite. Currently, the stock is priced at a forward EV/EBITDA of 7.4x, close to the peak of its 5-year valuation range, and 8% pricier than its 5-year average.
We wouldn’t be averse to paying this premium if the degree of EBITDA growth over the next few years was strong enough, but data from YCharts show that EBITDA CAGR through FY25 will come in at an unremarkable pace of a little over 2%.
Gauging insider sentiment towards a stock across different periods can also sometimes provide slight insight into what management thinks about the share’s current valuation. Well, in that regard, what we can see is that aggregate discretionary purchasing in Sep had come off in a big way from levels seen in August, and in the current month, there have been no purchases whatsoever.
The other thing to note is that even though ET primarily appeals to the retail cohort, there’s also ample participation from the institutional segment (40%), the guys with deep pockets, who often drive big moves in the stock.
If one looks at the size of the candles all through this year, one won't find too many large-bodied candles, implying the lack of institutional participation, and that's further reiterated by the data which shows that they haven't really participated in the rally this year, and have not shown any inclination to add to their positions all through this year. In fact, on a YTD basis, the net shares owned by institutions are down by over 15%. Granted, these guys don't always get things right, but yet still, when the institutional positioning is moving one way and the price is moving another way, one should perhaps pause and think twice.
Finally, also consider that ET is unlikely to benefit from any rotational interest in the energy infrastructure MLP space. Note that the relative strength ratio of ET as a function of AMLP is currently trading well above the mid-point of its 7-year range, and is also not too far from hitting levels from where the ratio has previously pivoted.
For further details see:
Energy Transfer: Some Compelling Narratives, But Not A Compelling Buy