On our most recent article on Energy Transfer (NYSE:ET), which you can read here, numerous commentators discussed the flaws around the company’s management team. Despite its large insider holdings, Energy Transfer’s management team has made numerous questionable decisions in the face of its obligation to long-term shareholder value.
The purpose of this article is to attempt to price the risk Energy Transfer’s management owes to shareholders, and whether the company is worth investing in in light of that.
Energy Transfer’s largest shareholder and major controller is Kelcy Warren, a billionaire pipeline mogul. He’s shifted positions around and varies in and out of Energy Transfer’s press releases, but he’s firmly the most powerful person at the company.
Plus, he’s a capital expenditure junkie. He loves building pipelines, and for years, Energy Transfer has spent billions on new pipelines, taking on more and more debt to do so. The company’s current long-term debt of roughly $50 billion has it firmly pressed up against the minimums for its investment-grade credit rating.
The company has started to finally make some concrete moves in 2020, cutting its dividend 50%, and drastically cutting capital expenditures, but it’s still given no true timeline or target for paying down debt.
The second issue with Kelcy Warren and management is their love of controversial pipeline projects, like the Dakota Access Pipeline, through Native American lands. While returns from controversial pipelines like this are potentially higher, the issue gets back to some fundamental issues about the United States’ historical treatment of its native people.
Regardless of your opinion on the matter, the pipeline is consistently a candidate to be shut down and emptied by future administrations, something that hurt the company this year. Donald Trump’s breeze through of permits for the pipeline, which Energy Transfer took advantage of, could come back to consistently haunt the company.
The culture of taking advantage of lax government regulations to do the bare minimum, and being open to lawsuits as a result, is one that often comes from the top. And it’s one that’s led to additional volatility and pain for shareholders.
Burned Shareholders and Acknowledging The Future
Another major potential impact for Energy Transfer is the business’s lack of willingness to adjust to climate change. The U.S. has joined seven other countries, like Turkey and Iran, in not partaking in the massive Paris Climate Accord, although President-elect Biden has announced that he intends to rejoin the agreement on his first day in office.
Climate change will always be a balance between no-bar economic growth and shareholder rewards. COVID-19 has, interestingly enough, supported things in the immediate term, leading to a drastic reduction in emissions. However, significantly, at some point, if not for financial reasons, the shift will happen. The IEA has acknowledged solar is the cheaper form of power.
Of course, there are massive storage and timeline issues with solar power. Natural gas will remain a significant part of our energy consumption for numerous decades to come. But just as Saudi Arabia has, it’d be prudent for Energy Transfer, especially with its debt load, to start to diversify its business. Even Energy Transfer acknowledges solar is a cheap power it can use.
Energy Transfer Renewable Energy – Investor Presentation
Energy Transfer continues to highlight the moves it’s been making due to renewable energy, as clearly visible above. However, we believe it’s time for the company to start making some more substantial steps.
At the end of the day, we’re a fan of Warren Buffett’s methodology for investing, and despite the risks, we recommend paying attention to the financials.
Energy Transfer path to FCF – Investor Presentation
Energy Transfer has a diversified business model with significant geographical diversity and a strong asset base. The company is cutting growth capital significantly, with a 60% decrease in 2021 from its FY 2020 forecast. The company has increased its project return requirements, although as we’ve seen above, the company needs to cut spending significantly.
The company has announced its long-term leverage target of 4.0x to 4.5x would imply a new debt of $41 billion to $46 billion versus roughly $50 billion currently. The company can hit that in a few years, achieving hundreds of millions in annual interest savings. It should be FCF positive in 2021, and versus its $15 billion market capitalization, its financials are strong.
We’d like to see the company aggressively pay down debt, driving higher shareholder returns.
Energy Transfer’s potential for returns is significant.
Energy Transfer Growth Capital and Financial Forecast – Investor Presentation
Energy Transfer forecast $3.3 billion in 2020E growth capital, of which it’s already spent a significant amount. The company’s 2020 DCF is roughly $6.8 billion, which will continue going forward. The dividends (pot cut) cost it roughly $1.6 billion annualized leaving $5.2 billion. 2021E growth capital will be $3.9 billion, up to $4.6 billion annualized going forward.
That represents significant FCF that the company can use for a variety of other things. The company can hit the midpoint of its debt targets in roughly two years with this FCF. We’d like to see the company commit to significant debt reductions for the longer term. Whether or not this happens needs to be seen, but the company’s financial strength can drive strong shareholder returns.
Realistically, the first step for the company is the financial strength to drive cash flow and rewards. Energy Transfer has that even if it hasn’t solidified how it’ll use it. The financial strength is incredibly important here – the company has a ratio of ~3 for market capitalization to post dividend and debt FCF. This will drive shareholder returns.
Energy Transfer’s risk is quite simple, it’s the lack of the company’s diversification, along with its debt load. We’ve already discussed the company’s debt load above and management decisions in significant detail above, however, whether these risks will continue to affect the company and to what extent remain to be seen.
Energy Transfer has an impressive portfolio of assets and the drive to support significant shareholder returns. The company has cut its dividend by 50% and significantly cut growth capital spending. That means that the company is now committed to consistently paying down debt, by close to $10 billion. How much it follows through remains to be seen, but the potential is there.
The company has other concerns, like issues around paperwork for the Dakota Access Pipeline. The financials are strong, but its management team needs to improve some of its decisions. Long term, we expect it to be able to provide strong shareholder returns, which is what fundamentally matters if you invest today.
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Disclosure: I am/we are long ET. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.