Beyond any doubt, one of the most fundamentally attractive companies on the market today is pipeline and midstream operator Energy Transfer (NYSE:ET). Recently, the company has seen a nice uptick in share price. This comes following the company’s acquisition of Enable Midstream and in response to strong fundamental performance and a positive outlook moving forward. Although shares of the company have appreciated meaningfully in recent months, the business does still appear to offer attractive upside potential. On top of this, the current and forward implied yields for the company should be considered attractive for investors and can deliver additional upside. Ultimately, I view this as a ‘strong buy’ prospect. I wouldn’t place it as my highest conviction play, but it’s not far off.
The future is looking great
The last time I wrote an article about Energy Transfer was in early November of 2021. At that time, I called the company significantly undervalued and I rated it a ‘strong buy’. Since then, shares of the company have performed exceptionally well. Investors who would have bought in at the time of the article’s publication would have experienced a profit of 23.6%. That includes reinvested distributions. By comparison, the S&P 500 has declined in value by 6.6% over the same window of time. That was not the only time I wrote about the company and its prospects that year. Earlier, in late August, I wrote another article that rated the company the same way. Since the publication of that article, shares generated a return for investors of 27.4% compared to the 1.2% decline seen by the S&P 500 over the same timeframe.
Although investors might point out that the energy market has, on the whole, been quite positive for investors, the cash flow picture of a business like Energy Transfer should not be anywhere near as volatile as companies operating in other aspects of the US energy industry. Though revenue for the company might fluctuate significantly, cash flows should generally be considered stable. Even during the 2020 fiscal year, when demand for oil and gas plummeted, operating cash flow for the company declined only modestly from $8.06 billion to $7.36 billion. Other profitability metrics also generally held up well, the one exception being net income. But net income is not really a great measure for a firm like Energy Transfer. DCF, or distributable cash flow, managed to drop from $6.25 billion in 2019 to $5.74 billion in 2020. And EBITDA for the company declined from $11.14 billion to $10.53 billion.
Strong fundamental performance for the company came back in 2021 with an increase in demand as the economy reopened and also because of inclement weather that helped to boost the company’s margins. For instance, storage margin alone for the company increased by $1.5 billion in 2021 relative to what it had been in 2020. At the end of the day, Energy Transfer saw its operating cash flow surge to $11.16 billion. DCF expanded to $8.22 billion. And EBITDA for the company came in at $13.05 billion. To cap off the year, management completed the purchase, in December, of Enable Midstream in a transaction that cost it $3.5 billion in stock and the assumption of billions of dollars of additional debt.
Now that 2021 is over, it’s time to begin looking into the 2022 fiscal year. So far, it appears as though management has high expectations for the company. As an example, the company currently forecasts EBITDA of between $11.8 billion and $12.2 billion. This comes in spite of the fact that the company does not have the inclement weather impact this year that it did last year, but is aided by the aforementioned acquisition. Beyond that, guidance for the company was rather sparse. However, if we assume that operating cash flow and DCF for the firm will decrease at a similar rate that EBITDA should, then operating cash flow should be around $10.27 billion, while DCF should total about $7.56 billion. For the purpose of valuing the company, I would like to make some adjustments to operating cash flow. For starters, I would like to remove estimated payments associated with non-controlling interests. I will simply take what the company paid out last year and apply it to the 2022 fiscal year as well. I also decided to strip out an estimated $421.78 million associated with payments that are to be made to preferred shareholders in the company. This gives me a reading for the business of $8.62 billion.
Given these figures, we can effectively value the company. Based on my calculations, on a price to operating cash flow basis, the company is trading at a multiple of 4.0. Meanwhile, the price to DCF multiple of the company should be 4.6. Another metric to consider is the price to free cash flow multiple. One thing that I love about many players like Energy Transfer is that management is very clear about the composition of capital expenditures. The company separates growth-oriented capital expenditures from those that are required to maintain current operations as they are. At present, the company should spend between $1.6 billion and $1.9 billion on growth projects for the year. A further $615 million to $665 million will be spent on maintaining current operations.
This allows me to calculate what I call the true free cash flow of the business. Basically, I ignore the growth capital expenditures in my free cash flow calculation because to not do so would essentially be punishing the company for its growth initiatives. The more the company plans to grow, the worse its fundamentals look if we don’t do this. Adhering to this idea, the price to true free cash flow multiple of the company should be about 4.3. And the EV to EBITDA multiple should come in at roughly 8.2, with a net leverage ratio for the business of 4.11. It is also worth noting that this does not assume any changes to guidance or the company’s fundamental condition from its recently-announced sale of its 51% interest in Energy Transfer Canada, a transaction that should result in net proceeds to the company of about $270 million.
Besides the cheapness of the stock, there is another benefit for investors who are attracted to yield. At present, the forward yield on the company is 6.2%. This is based on an effective annual payout, though paid out quarterly, of $0.70 per share. However, management has said that its target, eventually, is to hit $1.22 per share. If that comes to fruition, given the company’s current share price, that would drive the yield as high as 10.7%. That’s nearly as high as the historical annualized return of the broader market. So virtually everything above that comes in the form of capital appreciation would be gravy.
Based on the data provided, I will say that, to me, Energy Transfer strikes me as a compelling opportunity. I believe that shares are incredibly cheap, perhaps amongst the cheapest of any quality company on the market. Even if management does not grow the enterprise any further, I could see tremendous upside potential in the months and years to come. And as a result, I cannot help but to rate this prospect a ‘strong buy’ at this time.