Why Energy Transfer Can’t Get Respect

If Energy Transfer (ET) was a private company contemplating an IPO, the 15% Distributable Cash Flow (DCF) yield indicated by their underwriters would draw laughter. The bankers would be ushered out of the conference room.

Yet that is the lowly valuation investors assign to perhaps the least loved pipeline company in a sector that investors find lukewarm at best. ET is priced far below where they’d take the company public, if it wasn’t already a listed company. CEO Kelcy Warren and his team continue to execute and beat expectations on earnings. Last August Kelcy joked that, “A monkey could make money in this business right now.” (see Running Pipelines is Easy). Inviting critics to find fault, they nonetheless still deliver good results. Unlike most MLPs, ET (legacy Energy Transfer Equity) has never cut its distribution.

The market prefers style over substance, for on the soft issues of PR and Investor Relations (IR), ET’s record is sharply at odds with their financial performance. From their ill-fated pursuit of Williams Companies (WMB), the dubious dilution of shareholders with management-only convertible preferreds (see Will Energy Transfer Act with Integrity?) and the optically poor dispute over the Dakota Access Pipeline, this is a company that cares little about its image. Pennsylvania’s huge natural gas boom has been helped by a generally pro-energy regulatory regime, but ET has even managed to make enemies there.

ET’s PR staff must get combat pay.

Warren Buffett recently explained how Berkshire’s (BRK) $10BN investment in Occidental (OXY) was negotiated with no contingencies (save that they acquire Anadarko). Buffett needs to trust his investment partners. On this basis, ET is an implausible candidate for a BRK investment.

On the 1Q19 earnings call, Kelcy commented on how he is listening to the market. He’s been, “…trying to understand what the market would like to see us to do. What causes our unit price to perform better, in other words.”

Our advice would be start behaving like the kind of company that would interest Buffett.

ET’s 1Q19 earnings included EBITDA of $2.8BN and distribution coverage was ample at 2.07X. This exceeded expectations, although the 8% yield suggests some fear a cut. They guided to $10.7BN in 2019 adjusted EBITDA. ET’s stock had weakened over the prior month, so expectations weren’t high. Nonetheless, on the day following earnings ET slumped 1.3%, twice the drop in the broad-based American Energy Independence Index.

Kelcy Warren might compare ET with another big pipeline company, Plains All American (PAGP). If ET has delivered consistently good operating results distorted by a bad corporate image, PAGP has done the opposite. Their distribution relied unwisely on a volatile business segment (Supply and Logistics, S&L) whose arbitrage margins virtually disappeared from 2013 to 2017. The narrative accompanying results changed from “it’s skill not luck” to “forces out of our control”. The 2016 sweetheart “One and Done” preferred deal to shore up finances was anything but.

DCF Yield Growth ET vs PAGP

PAGP’s 2017 acquisition of the Alpha Crude Connector was ill-advised, and along with other growth projects exposed too-high leverage when margins fell. As a result, investors in PAGP subsequently suffered two distribution cuts.  Back in 2010 when the shale oil boom was in its infancy, PAA yield seeking investors received $3.75/unit in distributions.  In 2018 they received just $1.20 per unit.  It’s why income-seeking investors often feel so betrayed by MLPs. Nonetheless, the market has not punished PAGP’s stock as much as ET’s, although it’s also cheap. Former CEO Greg Armstrong’s folksy style created sufficient goodwill among investors that PAGP has a distribution yield a third less than ET’s. Their DCF and free cash flow are growing, but not as fast as at ET.

PAGP’s 1Q19 results were also good, buoyed by their resurgent S&L segment. Their 10% DCF yield reflects some concern that past mistakes will be repeated, and arbitrage margins are hard to forecast because they rely on shortages of pipeline capacity which can be fleeting. But their IR people at least have a more positive corporate image against which to tell their story.

As if to punctuate attractive valuations, on Friday Buckeye (BPL) was acquired at a 32% premium to its recent average price. BPL’s foray into international storage terminals led to chronic underperformance in recent years that even the buyout hasn’t rectified. They have mismanaged themselves into a takeover, at pricing substantially higher than ET’s.

Both ET and PAGP are cheap. They each possess skills that would benefit the other. ET’s rebarbative management style contrasts with their efficient execution and strategic foresight, an area where PAGP needs to regain credibility after mis-steps in recent years. ET walks the walk, and PAGP talks the talk.

If each company can improve its weaknesses, they’ll continue to draw investors to an extremely cheap sector offering substantial growth.

We are invested in BRK, ET, PAGP, and WMB.

SL Advisors is the sub-advisor to the Catalyst MLP & Infrastructure Fund.  To learn more about the Fund,  please click here.

SL Advisors is also the advisor to an ETF (USAIETF.com).

4 replies
  1. Tom Smith
    Tom Smith says:

    Let’s see: “Unlike most MLPs, ET (legacy Energy Transfer Equity) has never cut its distribution.” Are u kidding? My shares in ETP were yielding 11% three or four years ago when they were worth $59 a share. The share price has been sucked into two mergers always resulting in lower share price (now $15 and only 50% share increase) and lower distribution. Lately, Mr. Lack, your pumping is losing sight of facts.

    Reply
    • Simon Lack
      Simon Lack says:

      Tom, I think you’re confusing the regrettable history of Energy Transfer Partners (ETP) with that of the the GP, Energy Transfer Equity (ETE, now ET). ETE has not cut its distribution. In Energy Transfer: Cutting Your Payout, Not Mine we review the distributions of the various Energy Transfer entities in some detail to illustrate this point.

      Reply
  2. Elliot Miller
    Elliot Miller says:

    Once upon a time I owned both ET and PAA.
    I sold PAA before its issues arose and its distribution was reduced because I shifted my portfolio to emphasize natural gas, rather than crude oil, in my midstream investments.
    I sold ET because of the Kelcy Warren factor. When I owned it years ago, during the pre-2014 good times, the distribution was frozen in place . For several years Warren promised increases but he never delivered on that promise, so I sold my units because of disappointment with management. Then I was relieved when Warren took after WMB in an entirely ill advised and amateurishly executed acquisition attempt, which was highlighted by his preferred unit scheme to benefit himself and some insiders at the expense of the other unit holders, and which led to expensive and distracting litigation in Delaware (which, admittedly, he won). And while ETP itself didn’t reduce its distributions it did back door cuts by merging into it affiliates with higher distributions.
    Finally, I remember seeing an article (I think in the Wall Street Journal but it could have been elsewhere) about Warren’s mansion and comparing it to another’s, with Warren proudly describing his home’s opulence. He was very good at that job of PR, even if he can’t manage PR for ET.

    Reply
  3. Craig Stepnicka
    Craig Stepnicka says:

    Governance issues at ET and particularly the preferred Warren gave himself leave a bad taste for many investors. ET would do better if Warren stepped down

    Reply

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