These days are tough for most investors, including even those in firms like Energy Transfer (ET). Typically thought of as bastions of security during uncertain times, even these pipelines/midstream giants are finding themselves susceptible to the pain caused by recent events. During this period of pain and uncertainty, volatility can be your friend or your enemy. Based on management’s own thoughts regarding the future, it looks to me like investors in the business should take this opportunity, particularly when volatility is waxing bearish, to consider picking up shares of Energy Transfer if they don’t own them, or to pick up more if they do.
Pipeline/midstream service providers are often thought of as businesses that are immune to market conditions, but that’s not entirely the case. Even ones that enter into contracts aimed at guaranteeing cash flows have their limits. For Energy Transfer, you can see what I mean by looking at almost any of its cash flow metrics for the first quarter of its 2020 fiscal year. As an example, let’s take the business’s Adjusted EBITDA. During the quarter, this figure totaled $2.635 billion. This represented a decline of 3.7% compared to the $2.735 billion the firm generated in the first quarter of its 2019 fiscal year.
Adjusted EBITDA was not the only area where we saw a year-over-year decline. DCF (distributable cash flow) also took a hit. Company-level DCF came out to $1.836 billion. This is 5.2% below the $1.937 billion seen a year earlier. This is not, however, the DCF that investors should be paying attention to. You see, Energy Transfer is a large and complicated company, with many working parts to it. What really matters on the DCF side at the end of the day is the DCF attributable to the firm’s partners. This figure was $1.417 billion, which was 11.1% lower than last year’s $1.594 billion. This drop compared to the first quarter of 2019 did harm the firm’s distribution coverage ratio, bringing it down from 1.99 to 1.72. Even so, 1.72 is a robust figure and investors should be happy that it’s this high in the current environment.
Perhaps the only metric where Energy Transfer fared better year-over-year was operating cash flow. According to management, this figure came out to $1.816 billion, just a hair over the $1.815 billion seen the same quarter a year earlier. One thing that I pay close attention to is what I call “true free cash flow”. This is stripping out only maintenance capex from operating cash flow to see what kind of cash flow the company could generate in perpetuity if it abandoned its growth ambitions. With $103 million in maintenance capex in the first quarter compared to $92 million a year earlier, true free cash flow did decline from $1.723 billion last year to $1.713 billion this year. That drop, though, at only 0.6%, is not really anything to worry about. If anything, given the current environment, the reading is quite impressive.
Still an excellent prospect
Because of first-quarter results and due to what is happening in the second quarter today, management has had to make some adjustments to its fiscal year forecast for 2020. For starters, the company has decided to reduce growth capex by $400 million from about $4 billion to $3.6 billion. The firm is also evaluating other potential cuts of between $300 million to $400 million, depending on market conditions. The second big change relates to Adjusted EBITDA. If current market conditions are as management anticipates moving forward, the company is forecasting this metric to range between $10.6 billion and $10.8 billion for a midpoint for the year of $10.7 billion. This compares unfavorably to the $11 billion to $11.4 billion the company was anticipating when it first released guidance earlier this year.
Sadly, management does not offer any sort of substantive outlook beyond Adjusted EBITDA, but we can get some sort of idea as to what the company’s future might look like. Annualized interest expense of $2.4 billion can be subtracted from Adjusted EBITDA to give us a sort of normalized operating cash flow. Maintenance capex for the current year should be between $550 million and $590 million, for a midpoint of $570 million. This gives us true free cash flow for the year of $7.73 billion. Distributions to partners should be $3.3 billion for the year, give or take $100 million. This brings us down to $4.43 billion. This measure is more than enough to cover growth capex of $4 billion, but there are some problems with it.
As I mentioned before, Energy Transfer is a very complex firm structurally. The company has various responsibilities, like cash flows to and from noncontrolling interests and preferred distributions, that are technically listed under investing and financing activities. Even so, the nature of these items means that to be philosophically honest, they should be factored out of true free cash flow to get a real sense of free cash flow for the firm. By my estimate, annualizing the figures we have, we get about $2.1 billion in adjustments that should be factored out. This brings true free cash flow to $2.33 billion, for a deficit this year versus what planned growth capex is of $1.27 billion.
Another way to look at the firm is by annualizing its DCF. This may be the better way. Annualizing it, we get $5.8 billion. Take out distributions of $3.3 billion to bring this down to $2.5 billion. The disparity here gives us a deficit of $1.10 billion. Both this reading and the one before it suggests the firm will either need to issue shares, take on debt, or come up with some other arrangement in order to cover its spending for the rest of this year. Even so, this is not all that bad when you consider that this growth capex will go on to create additional cash flows for the company in the long run.
Right now, the market is not too happy with the oil and gas industry. Certainly, there is a lot of pain in the space right now. Enough pain, in fact, that Energy Transfer has even had to revise down its forecasts for the current fiscal year. Despite this, investors should take solace in the fact that the company appears to be on really solid footing, and that if estimates are accurate, it and its distribution (which results in a yield today of 16.25%) make this a strong, long-term prospect to consider.
Crude Value Insights offers you an investing service and community focused on oil and natural gas. We focus on cash flow and the companies that generate it, leading to value and growth prospects with real potential.
Subscribers get to use a 50+ stock model account, in-depth cash flow analyses of E&P firms, and live chat discussion of the sector.
Sign up today for your two-week free trial and get a new lease on oil & gas!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.