Description

Energy Transfer (ET)

ET was founded in 1996 as a small gas pipeline operator, growing through acquisition in the 2000s. Today, it is one of the largest midstream companies in the US with $55 billion in annual revenue. Core business lines are transportation, storage, and terminaling for gas, crude oil, and NGLs.

The core ET investment thesis is:

1. Low-risk toll road business with strong cash flow

2. Cash flow inflection expected in next 12 months

3. Risks around corporate structure and management overstated

1.     Low-risk toll road business with strong cash flow

The company is a low risk ‘toll road’ business with stable cash flows. 85-90% of its margin is fee-based, with the balance spread evenly between commodity margin and spread margin (pipeline basis, as well as commodity and time spreads).

Current distribution yield of 9.1% is well covered. Management has said they expect 1.7-1.9x long term ratio of distributable cash flow to distributions paid to partners (was 2.1x in 1Q19).

Diversified Geographic Footprint

ET has a geographically diversified footprint with a presence in key major drilling regions.

Source: ET June 2019 Investor Presentation.

ET Operating Segments

ET’s diversified cash flow streams mean EBITDA comes from a combination of NGL, refined products, crude oil, interstate and intrastate pipelines, midstream, and other.

Source: ET June 2019 Investor Presentation.

2.     Cash flow inflection expected in next 12 months

ET is completing a multi-year capex program. Management is guiding to $5 billion in growth capex for 2019 versus a longer-term run-rate of $3-4 billion (primarily a proposed new LNG terminal in Lake Charles and a VLCC facility in Texas). EBITDA minus capex slash distributable cash flow will grow nicely as a result.

For reference, 2019 maintenance capex is expected to be $520-$560 million. EBITDA is expected to grow nicely over the next 2 years as the capex program investments come online, a possible source of additional upside.

3.     Risks around corporate structure and management overstated

ET is the surviving entity after two key corporate transactions. In 2016, Sunoco Logistics Partner and Energy Transfer Partners (ETP) merged to combine two MLPs sponsored and managed by ET ((then called Energy Transfer Equity or ETE). In 2018, ETP and ETE combined to form ET. In both transactions, investors suffered a so-called “shadow distribution cut” which reduced their effective cash distributions. This reduction was received poorly by yield-sensitive MLP investors.

Further, back in 2015 ET protected itself against an unwanted acquisition attempt by selling convertible debt that caused technical issues for the deal and ultimately caused the would-be buyer to walk away. A big chunk of that convertible was issued to Founder, Chairman, and CEO Kelcy Warren, which many investors considered a form of (lawful) self-dealing.

ET Ownership Structure

Source: ET June 2019 Investor Presentation.

Today, Kelcy Warren’s economic exposure to ET (and roughly three-quarters of his $4.3 billion net worth according to Bloomberg) is in the form of his direct and indirect ownership of ET units. The company is very focused on growing distributable cash flow, which is Mr. Warren’s primarily source of personal income from ET (he has a salary of $1). 

Catalyst

- Increase in distributions post reduction in growth capex program

- EBITDA step up once multi-year capex projects come online

- ET re-rating vs. peers