Energy Transfer (NYSE: ET) is not only the largest master limited partnership (MLP), but it also pays one of the highest-yielding distributions in the energy sector at 8.7%. Usually when a payout approaches a double-digit yield, it's a cause for concern. Here's a closer look at the midstream company's financial metrics to determine whether that's the case.
A closer look at the stability of its cash flow
Energy Transfer is on track to produce between $10.6 billion and $10.8 billion of adjusted EBITDA in 2019, which would be about 12.5% above 2018's level. The company has high confidence that it can achieve this forecast. That's due in large part because long-term, fixed-fee contracts supply it with about 85% to 90% of its anticipated cash flow each year. While the other 10% to 15% does have some variability due to the volatility of oil and gas prices, Energy Transfer's cash flows are much more stable than those of most energy companies.
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Further, the company's stable earnings should continue expanding in the coming years as it completes more expansion projects. Energy Transfer currently expects to invest $5 billion on expansions this year, which will help drive growth in 2020 and beyond. Meanwhile, it has a long list of projects in development, which should continue pushing cash flow higher in the years to come.
Drilling down into distribution coverage
Like most MLPs, Energy Transfer distributes a large portion of its earnings to investors each year. During the first quarter, the company generated $1.656 billion in cash and paid out $800 million of that money to its investors, meaning it covered its distribution by 2.07 times. That's a big improvement from the sub-one times coverage it had before acquiring its MLP last year.
Energy Transfer anticipates that it will maintain a healthy distribution coverage ratio in the coming years. The company's current long-term target is for coverage to be in the 1.7 to 1.9 times range. That will enable the MLP to retain $2.5 billion to $3 billion of excess cash per year that it can use to invest in expansion projects, pay down debt, or repurchase its units.
Energy Transfer has invested billions of dollars in recent years to expand its midstream footprint. That caused the company to borrow lots of money to help fund its growth, which pushed its leverage ratio to an uncomfortably high level of more than 5.5 times debt to EBITDA in 2017. The MLP has worked hard to get that metric down over the past year. As of the first quarter, it was around 4.7 times. That puts the midstream company closer to its aim of decreasing its leverage ratio to between 4.0 times and 4.5 times.
Credit rating agencies are starting to take notice of this improvement. Moody's, for example, revised Energy Transfer's credit outlook from negative to stable late last year while putting it on review for an upgrade. Meanwhile, Fitch and S&P Global have both upgraded the company's credit to investment grade in the past several months. These moves not only allow Energy Transfer to borrow money at cheaper rates but also increase its access to credit, which improves the long-term sustainability of its distribution.
Verdict: Energy Transfer's dividend appears to be safe
Energy Transfer has significantly enhanced the safety of its high-yielding dividend over the past year. As the company's metrics show, it's comfortably covering its payout with stable cash flow, which it further supports with an improving balance sheet. Meanwhile, with lots of growth up ahead, Energy Transfer should soon be in the position where it can start increasing its payout once again.
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