The thesis of the article
Power transfer (NYSE:ET) is a leading American energy infrastructure company with the largest asset base on the continent. It generates large amounts of money, but its value is not very expensive, as others, including previous investors, it was considered unfunded due to dividend cuts during the pandemic. But Energy Transfer has made it clear that returning their dividend to pre-pandemic levels was their main goal, and with the latest dividend increase on the books, ET is well on its way to doing just that. Investors get a good dividend yield, more dividend growth is possible, and ET also has high potential due to its very low price.
Great assets but unloved
The world is facing an energy crisis today. Oil, natural gas, coal and electricity are very expensive in many markets around the world. At the same time, companies active in the production of these products have been reducing investment in recent years, for many reasons, including ESG mandates and the pandemic. Demand has not slowed, however. Instead, it continues to grow, which is why many of these products’ markets have strengthened in 2022. Add OPEC’s decision to cut oil production to keep supplies tighter, and global energy markets are scrambling to find any supply that might be available. . In that area, American energy, or more precisely oil and natural gas, is very important both in the US itself and in foreign markets, such as Europe and East Asia.
Exports of US-produced oil, petroleum products, and natural gas (in the form of LNG) will be very important to the world going forward, and that bodes well for companies that provide the necessary infrastructure. Energy transmission pipelines, storage facilities, terminals, etc., are of great importance to the world, as they help to supply much-needed energy products to the markets where they are needed — domestically and internationally, eg. by delivering natural gas. at LNG export terminals.
And yet, despite the importance of this industry, these stocks are not popular with investors. That’s true of many energy stocks, as they all tend to trade at unwanted valuations. But this low valuation is even more pronounced when it comes to Energy Transfer, which trades very cheaply even among its peers. There are many reasons for that. First, the investment community is concerned about ET’s debt levels. They are higher than those of Enterprise Products Partners (EPD), for example, but Energy Transfer does not appear to be threatened by its debt. After all, the company has been reducing its debt capacity, and growth in EBITDA should lead to an improvement in leverage. With so much free money being made even though ET payments have to be made, there is little reason to worry about its debt, I believe.
The excess of power is not acceptable to others for their decision to reduce the dividend during this epidemic. It hasn’t been too good for investors, as companies are holding onto their shares in times of crisis. But ET did not eliminate its dividend (it was cut in half), and the company has made progress in returning the dividend to its old pre-crisis level. I don’t think the track record is so bad that ET should trade forever at a very low price. This means that investors who can look beyond the dividend cut in 2020 can load up on cheap high-yield shares that operate in an area where its assets are more important and more valuable month by month, as many markets are cyclical. The globe wants to restore energy exports to Russia, instead moving to suppliers such as the US.
A dividend recovery is on the way
On Tuesday, Energy Transfer announced that its next dividend payment will be $0.265 per share (quarterly), which is a 15% increase from the previous level of $0.23.
This is consistent with the last two quarters, where Power Transmission has increased the dividend regularly and at a meaningful rate as well:
From a record low of $0.1525 per share, ET has now increased its dividend by 74% in one year. Another 15.1% dividend increase is required, and ET’s dividend will return to the pre-crisis level of $0.305 per share per quarter. I believe there is a high probability that this will be done in the quarter from now, as ET increased the increase in its shares, in absolute terms, in the last two quarters. The first trip was 2.25c, with subsequent trips at 2.5c and 3.0c. The most recent dividend increase, which was just announced, was 3.5c. If ET increases the dividend by 4c in the next announcement, then the dividend will be in line with where it was before the pandemic. That would be a slightly larger increase, in absolute terms, than during the most recent announcement. But that thing was a little bigger than the previous one, etc., so it would match what ET did.
We can also look at the quarter-to-quarter growth rate, which has been in the 15% range for all four dividend increases. Since a dividend increase of 15.1% will be required for ET to return the dividend to the old level, it seems reasonable to me to think that this is what Energy Transfer will do a quarter from now.
At that time, ET’s dividend yield will be 10.2%, based on a share price of $12. That would be very attractive. The dividend yield, based on the most recent dividend announcement, is 8.8%, which is strong as well. Even better, the dividend looks stable at these levels, and could be raised above $0.305 at the end of the quarter.
Power Transfer has predicted that its EBITDA will be worth about 12.7 billion dollars this year. Not all of that will turn into cash transfers, of course. When we adjust for interest expense, maintenance capital expenditures, projected growth expenditures, EBITDA attributable to minority shareholders, and preferred stockholders’ equity, the $12.7 billion in EBITDA should translate to approximately $6 billion to $6.5 billion in free cash flow. — and all capital expenditures. already calculated. Going with the low end of that estimate, ET will be able to return $6 billion a year to its investors, even as it continues to invest in maintenance and some growth. At $0.305 per quarter / $1.22 per year at a level that I believe will hit quickly, ET’s dividend will be worth 3.8 billion per year, based on the number of shares of 3.09 billion. In other words, ET will pay less than two-thirds of free cash flow in that case. Growth spending is forecast to slow in 2023 and beyond, so free cash flow should be high in the future.
It is far from certain that ET will pursue future share growth beyond the pre-crisis share recovery. And it’s not a trick, I believe. In fact, I think that going for buybacks after the dividend is returned would make a lot of sense, as the shares can be bought back at a very low price, which will not make the dividend safe over time, but it will have an effect. in cash flow growth per share over the years. It is highly likely that ET shareholders will not receive any dividend increase for some time after the old dividend is fully restored, but if ET management uses the $2+ billion of surplus cash for debt reduction or buybacks, that will create shareholder value. price as well. However, the above calculation shows that ET has a lot of power when it comes to increasing the dividend – if the company wants to pay $ 1.50 per share per year, that will cost the company about 4.6 billion per year, for example. it is still easily covered by our free cash flow estimate of $6 billion. A hypothetical $1.50 per share would result in a dividend yield of 12.5% for someone buying at $12.
Power distribution is not popular, but it offers opportunities for investors. ET has rallied over the past year, but remains relatively cheap, trading at around 6x this year’s free cash flow now – with all growth expenses already accounted for.
With a dividend yield of 9% that could rise to 10% per quarter from now, ET is a strong income option. And its dividend is very stable at those levels, making it an outlier relative to many other top stocks. Whether we investors will receive an additional dividend increase after the dividend is fully reinstated, or if ET chooses to further reduce debt or repurchase, it appears that the company has many ways to create significant shareholder value over time. I continue to be happy with my investment in ET.