Energy Transfer (NYSE: ET) has worked hard over the past few years to turn itself around. The midstream company has streamlined its structure and improved its balance sheet, all while undertaking one of the more ambitious expansion programs in the energy infrastructure sector.
These moves have significantly enhanced the company's financial profile, putting its 7.9%-yielding dividend on a much more sustainable footing. Because of that, it's one of the more compelling stocks out there for yield-focused investors.
From suspect to sustainable
In 2017, Energy Transfer's predecessor company (Energy Transfer Equity) paid out all its cash flow and then some to investors via its high-yielding dividend. That high payout percentage was due in large part because Energy Transfer Equity was supporting its former master limited partnership (MLP), Energy Transfer Partners, which needed help funding its massive backlog of expansion projects. The companies undertook several strategic actions last year to help address that issue, including joining forces to create one large-scale midstream company.
Those efforts have paid off. For starters, the new Energy Transfer was able to generate enough cash to cover its payout by a much more comfortable 1.74 times in 2018, a vast improvement from its 0.96 times coverage ratio in 2017 on a stand-alone basis. One of the main fuels of the improved payout ratio was its record-breaking cash flow, thanks to the completion of several needle-moving expansion projects. In addition to that, the company significantly strengthened its financial profile through a series of strategic moves.
Energy Transfer is on track to continue expanding earnings at a healthy clip in 2019, with it anticipating double-digit growth. That leads the company to believe it can cover its high-yield dividend by a comfortable 1.7 to 1.9 times in 2019, positioning it to produce $2.5 billion to $3 billion in excess cash. The company intends on using that money to cover about half of its planned spending on growth projects this year.
Getting close to hitting another inflection point
Energy Transfer plans to maintain its current distribution rate for the time being. The priority right now is to finance its current slate of expansion projects while at the same time continuing to strengthen its balance sheet. However, once the company is at its desired credit metrics, it has two options for its growing stream of free cash flow. "You're going to see either the resumption of distribution increases to our unitholders, which I hope is the case, or if the market doesn't suggest that's what we should be doing, then you'll see us do unit buybacks," according to CEO Kelcy Warren on the third-quarter conference call.
Given the company's current dividend yield of nearly 8% and its dirt cheap valuation, the company appears likely to opt for a repurchase program rather than a distribution increase. That's because buybacks are becoming increasingly popular in the energy sector, even with midstream companies, as both Kinder Morgan (NYSE: KMI) and Enterprise Products Partners (NYSE: EPD) have authorized $2 billion programs in recent years.
The reason energy companies are going the buyback route is that valuations remain cheap across the sector, which is the case for Energy Transfer since it trades at the lowest value in its peer group. On the other hand, the company could follow the blueprint of Kinder Morgan and Enterprise Products Partners by authorizing a buyback, as well as a more modest distribution increase. Either way, it seems likely that the company will be sending more cash to investors in the future.
A big-time yield that could get even bigger
Energy Transfer has gone to great lengths over the past few years to shore up its financial profile and improve the long-term sustainability of its high-yield dividend. Those efforts have put the company's payout on its strongest footing in years. Because of that, Energy Transfer should be able to start returning more cash to investors in the coming years as it continues to improve its financial profile while expanding its portfolio of cash-generating midstream assets.
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Matthew DiLallo owns shares of Enterprise Products Partners and Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.