The lure of Energy Transfer's (ET -1.57%) high yield is difficult to ignore, especially when the stock has fallen to such attractive levels. Speculating on where Energy Transfer stock is headed is difficult. However, there are factors that contributed to its fall. And those concerns are far from resolved. In fact, the worries have risen even more.
High leverage
Energy Transfer's debt levels have always been a concern of investors. The company's long-term debt rose from $43.4 billion at the end of 2018 to $51 billion at the end of 2019. For comparison, Enterprise Products Partners' (EPD -0.83%) debt roughly doubled in the last ten years, while that of Energy Transfer's rose more than four times over the same period. Similarly, Energy Transfer's debt-to-EBITDA ratio has historically been much higher than that of Enterprise Products Partners.
ET Total Long Term Debt (Annual) data by YCharts
Energy Transfer's higher leverage highlights the company's aggressive growth strategy, which puts shareholders' interests at risk. It would probably have been better for Energy Transfer to use a part of its earnings to reduce debt, rather than to invest in projects with marginal returns just for the sake of growth.
With the challenging commodity price environment and bleak demand outlook for energy commodities, earnings of energy companies are surely going to be impacted. Certain Energy Transfer's credit facilities require a minimum EBITDA for the debt that the company owes. If earnings go down, the ratio may fall below that required by the credit facilities, triggering restrictions, including on distribution payments. The MLP may be forced to slash its distributions to maintain leverage, which may further hurt the stock. Moreover, a high leverage may negatively impact Energy Transfer's credit ratings, making it more expensive to raise funds.
On the positive side, the company has been growing its earnings steadily. The distributable cash flow for 2019 was roughly 2 times the distributions paid for the year.
Concerns relating to the MLP structure
Despite higher leverage, Energy Transfer managed to grow distributions at a higher rate than Enterprise Products over ten years. However, while Energy Transfer's distribution grew, the company had effective cuts at Sunoco Logistics Partners and Energy Transfer Partners -- former LPs in the complex Energy Transfer group. This highlights the company's governance issues which have long been another key concern of investors.
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It wouldn't be a surprise if the company makes another backdoor cut as part of transition to a C corporation. A C corp conversion may also have significant tax implications for unitholders, especially for the long-term holders with a low cost-basis. With the kind of interest that investors now have for MLPs, Energy Transfer stock may have a difficult time to gain back its losses while maintaining the MLP structure.
Overall, Energy Transfer stock's fall has made its yield attractive. However, if earnings fall, a high leverage may force the company to reduce distribution payments, further hurting the stock. Energy Transfer sure has an upside if commodity prices stabilize and demand doesn't get hit too much. All in all, it’s a high risk, high reward stock at the moment. For conservative income investors looking for a stable dividend income, its surely a risky bet.
