Is energy transfer stock a purchase?

Energy transfer (NYSE:ET) the stock is surely the most affected stock among its major MLP peers. Since October 2018, when Energy Transfer Equity and Energy Transfer Partners merged to form the current entity, the stock has fallen around 63%. In comparison, the best MLP peers Enterprise Product Partners (NYSE:EPD) and Magellan channel partners (NYSE: MMP) fared better, although these too could not escape the impacts of broader energy market challenges. Energy Transfer shares are currently trading at a very attractive price. Is the market overlooking an opportunity?

HEY given by Y-Charts

High leverage

Energy Transfer’s underperformance over the past two years is not without reason. The company is struggling with several issues that are reflected in its declining share price.

First, energy transfer is highly leveraged. In uncertain and difficult times like these, this is a big deal. Energy Transfer’s debt has quadrupled in less than a decade, thanks to its numerous acquisitions and growth projects. Company debtEBITDA The trailing 12-month ratio is 5.7 times, which is considered quite high even for a highly leveraged business like infrastructure. For comparison, the ratio for enterprise product partners is 3.6 times. Energy Transfer’s aggressive growth strategy of taking on debt to continue expanding may not be in the best interests of its shareholders. A rising debt-to-EBITDA ratio likely indicates that the company’s projects are generating lower returns at relatively higher expenses.

If Energy Transfer’s debt-to-EBITDA ratio continues to rise, covenants in its credit facilities could force it to reduce its distributions. The company could also experience a credit rating downgrade from rating agencies, which would lead to higher borrowing costs. Moody’s recently changed its outlook for energy transfer from stable to negative, while maintaining its Baa3 rating. The rating agency cited a recent court order forcing the company to shut down its Dakota Access pipeline as the reason for the change in outlook.

Bunch of pipelines

Image source: Getty images.

Regulatory risks

In addition to high leverage and the resulting risk of distribution cutoff, Energy Transfer also faces regulatory risks on its pipelines. In the latest example of such a risk, a district court recently ordered the closure of Energy Transfer’s main Dakota Access pipeline by August 5, pending an environmental review. The company intends to file a motion for a stay of the decision.

The Dakota Access pipeline is one of America’s most controversial pipeline projects. The pipeline began operations in 2017 after years of controversy and environmental reviews. After three years of operation, the current order may not shut down the pipeline for long, but it still highlights one of the key risks facing pipeline operators. In all scenarios, Energy Transfer must, at a minimum, incur costly legal fees to continue operating the pipeline. Notably, a temporary shutdown might not have a major impact on Energy Transfer’s overall earnings, as Dakota Access contributes less than 5% to the company’s earnings. However, the frequent controversies surrounding Energy Transfer pipelines highlight the company’s risk in this area.

Counterparty risks

Another key risk that Energy Transfer faces is default on contract payments by producer customers facing bankruptcy. Chesapeake EnergyLast month’s bankruptcy filing is a good example. As part of the restructuring, Chesapeake wants its $293 million contract with Energy Transfer on its Tiger pipeline will be cancelled.

Of course, counterparty and regulatory risks are not limited to Energy Transfer. All pipeline operators deal with these risks. However, it is the magnitude of the risk, coupled with high leverage, that makes Energy Transfer’s situation more alarming. In March, 81% of Energy Transfer’s unsecured credit exposure was to investment grade counterparties. While this sounds impressive, it includes Energy Transfer’s internal ratings for counterparties not rated by rating agencies. In the absence of published notes, this leaves the picture unclear. Basically, the company doesn’t have too much leeway if things go wrong on any front.

A risky bet

Energy Transfer’s stock price and high payout yield look incredibly tempting. Its vast asset footprint has a lot of value because it takes years to build pipelines. However, the waiting period for the possible resumption of stock could be very long and could be accompanied by a reduction in distribution. Moreover, looking at his track record, the company is prone to frequent, if not endless, problems due to its aggressive growth strategies. I think it’s better to look for interesting opportunities somewhere else than making this risky bet.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

About Andrew Miller

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