Energy transfer (ET 3.23%) it has a very attractive yield at 6.9%. That will attract the eyes of most income investors today, noting that the S&P 500 Index it has a miserly yield of only 1.2% or so. Even the average energy yield is much lower, at about 3.1%.
Before buying energy transfer, thinking that you will set up with a life of income, however, you will want to consider some facts about the past.
The Energy Transfer business looks attractive
Energy transfer is what is known as a midstream company. It owns energy infrastructure such as pipelines, storage facilities, transportation equipment and processing assets that are vital to the day-to-day operation of the overall energy industry.
However, unlike the upstream sector (oil and gas production) and the downstream sector (chemicals and refining), midstream assets are generally not affected by commodity prices. Customers generally pay fees for the use of vital infrastructure assets that companies like Energy Transfer own.
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A fairly reliable stream of fee income is what supports distributions paid by midstream players like Energy Transfer. In this sense, it makes sense that investors focused on income will be attracted to this master limited partnership (MLP).
Adding to the allure is the fact that the company has an investment quality balance sheet, and that its distributable cash flow covers the distribution of the third quarter by a strong 1.8 times.
It is also quite diversified. It spreads its business roughly equally in four different midstream sub-sectors and a division dedicated to its ownership interests in other midstream companies.
In some ways, it looks like a one-stop shop in the midstream niche. But don’t just buy it; there is a bit of history here that you should consider.
What happens when the energy sector is in trouble?
From a distance, it looks like Energy Transfer should be able to use its rate-driven business to easily steer through an energy industry downturn. Only that is not what happened in 2020, when the pandemic led to a sharp drop in energy prices.
During that industry weak patch, the MLP actually ended up cutting its distribution in half. To be fair, there was a great deal of uncertainty in the world at the time, so this move was probably a precautionary measure that made a lot of sense given the circumstances. And the distribution is now higher than before the cut.
However, just when income investors were to look to the Energy Transfer for income security, he left them. Other midstream competitors have managed to maintain or even increase their dividends.
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The company also did not stand out during the previous energy crisis. In 2016, the MLP ended up trying to get out of an acquisition it had started. Completing the purchase, according to management, would have left Energy Transfer with a debilitating debt pile and may have forced it to cut its dividend.
It made sense to try to scuttle the deal. But the effort to do that included the sale of convertible securities, a large part of which went to the then CEO (who is now the chairman of the board of directors).
The convertible bonds would have effectively protected the CEO from a dividend cut if the deal had gone through. Again, just when investors would have sought to be front and center with management, they were not.
Power transfer may not be the best option
The problem with the MLP is not so much the business as the trust. It has a high performance that seems well supported. This distribution has grown over time.
But what can an investor expect when the chips are down? If this question worries you, as it probably should, given Energy Transfer’s history, you may want to look elsewhere. Competitors like it Enterprise product partners (NYSE: EPD) and Enbridge (NYSE: ENB) have a much better track record of putting income-focused investors first.