-ETE Distribution Yield: 4.28%
-ETE Five Year Distribution Growth: 12.6%
-ETP Distribution Yield: 7.41%
-ETP Five Year Distribution Growth: 2.8%
-Balance Sheet: Highly Leveraged, but Stable
Over the last two years, the Energy Transfer set of investments has exploded in complexity. I currently view both ETE and ETP as investments that remain appealing purchases in this rather highly valued market, but until consolidation occurs an accurate valuation is difficult to come by. Therefore this report is being published as an “update” rather than an “analysis”, as the primary focus will be on a qualitative overview rather than a quantitative assessment.
OverviewThe Energy Transfer set of investments is currently among the most complex investments traded on the public market, and management’s current focus is primarily on simplifying the organizational structure.
The set of investments exists as a combination of master limited partnerships and corporations.
I previously analyzed ETE about 20 months ago in 2011 with a 3,500 word analysis that can be found here. That analysis is currently quantitatively outdated but includes a lengthy description on the risks and benefits of owning a general partner like ETE, and in that article I proposed that the price at the time of under $37/unit was a very attractive purchase. It has since then gone up to just under $60/unit while paying also paying a fairly high yield.
At the time of that article, the ownership structure was reasonably complex but fairly straightforward to value, with ETE owning the general partner, 100% Incentive Distribution Rights (IDRs), and a portion of the limited partnership units, of both Energy Transfer Partners (ETP) and Regency Energy Partners (RGP). Now in April of 2013, after a series of mergers and acquisitions, the investment structure has enormously grown in complexity.
The history of the events can be summarized as:
-ETE acquired Southern Union which held attractive pipeline assets in Florida, and then dropped down the most important assets to ETP.
-ETP acquired Sunoco Inc., including their retail gas assets and their holding of Sunoco Logistics Partners (SXL).
-ETE and ETP formed Holdco to consolidate some of these assets. ETE shifted their Southern Union assets to Holdco, and ETP shifted their Sunoco Inc. assets to Holdco but held onto the SXL ownership (the GP, IDRs, and a portion of the LPs) directly. ETE owned 60% of Holdco while ETP owned 40%.
-Some non-core Southern Union assets were sold to an outside entity.
-Southern Union Gas Company was sold to Regency Energy Partners (RGP).
-ETE and ETP reached an agreement to sell ETE’s stake of Holdco to ETP for $2.35 billion in ETP units and $1.4 billion in cash. This is a the key part of consolidation into a simpler structure.
The current situation remains complex, and is a three-tier publicly traded structure. As this Holdco sale finalizes, the structure will be as follows:
-ETE as a publicly traded entity will continue to own the GP, 100% IDRs, and a portion of the LP units of both ETP and RGP.
-ETP as a publicly traded entity will own its core assets as well as Sunoco Inc. (gas retail), the remaining Southern Union Assets, and the GP, 100% IDRs, and a portion of the LP units, of Sunoco Logistics Partnership (SXL).
-RGP as a publicly traded entity will continue to operate as a fairly independent partnership with its GP owned directly be ETE.
-SXL as a publicly traded entity will continue to operate as a fairly independent partnership with its GP owned directly by ETP (and partially and indirectly by ETE due to ETE’s ownership of ETP’s GP).
(Chart Source: DividendMonk.com)
The chart value for 2013 extrapolates the current quarterly distribution of $0.635 (up from $0.625 from last quarter) throughout the year, and therefore is best understood as an estimated minimum distribution for the year.
Distribution growth stalled for several quarters during this period of mergers and acquisitions. The primary reason was that for these sales to work, ETE had to temporarily waive its share of the IDRs of the assets it was selling to ETP. ETE began resuming its distribution in 2013 and appears to be set for decent distribution growth as the structure simplifies and as they eventually get access to their full IDRs on these various assets.
The current distribution yield is 4.28%.
(Chart Source: DividendMonk.com)
ETP has held its distribution steady without growth since mid 2008.
Like the last chart, this chart value for 2013 extrapolates the current quarterly distribution throughout the year, and therefore is best understood as an estimated minimum distribution for 2013.
Distributions have remained flat for a frustrating period of time for ETP investors. As ETP has acquired these assets and grew considerably, they have issued units to fund these purchases, and have been able to maintain but not grow their distribution payments. I do expect ETP to boost its distribution before 2014, and according to recent presentations, it’s a large focus of ETP management to resume increasing its distribution as it cuts costs and finds synergies in its consolidating set of new assets.
The current distribution yield is 7.41%.
Between ETE and ETP, ETE as the general partner is expected to have a lower distribution yield and higher distribution growth, while ETP is expected to maintain a higher distribution yield while having lower distribution growth.
Balance SheetETP currently has a Baa3 credit rating while ETE has a Ba2 credit rating from Moody’s. This puts ETP on the low side of investment grade, and ETE into the non-investment grade category.
Each partnership holds debt, and then ETE holds stakes in those partnerships while also having its own parent debt, which is why ETE is more leveraged than any other entity in this structure.
Investment ThesisPredicting where this investment is going to go involves two primary areas of focus. The first is to focus on potential areas of growth for this set of investments, and the second is to focus on the changing structure of the set of investments.
Over the last decade, Energy Transfer expanded from a small set of assets in Texas to one of the largest energy companies in the country. They now own pipelines, terminals, storage, and other facilities throughout all of Texas, Louisiana, and Florida, as well as in the mid-western states and northeastern states. Sunoco gas stations are now part of the portfolio as well.
The partnership continues to expand in the Eagle Ford Shale of Texas, as well as with the Godley Plant Expansion, the SUGS Red Bluff Project, the SUGS Mi Vida Project, and the Mont Belvieu Fractionators.
A longer-term project is the Trunkline Crude Oil Conversion Project, which is expected to be in service in 2014. Then there’s the much longer-term LNG Export Project expected to be in service for 2018-2020.
ETP (and indirectly, ETE) is positioned to benefit from increasing SXL distributions. Now that SXL is hitting its top distribution tier, 50% of cash above this level goes to ETP in the form of IDRs. So for example, a 24% increase in SXL limited partner distributions results in a 45% increase for distributions to ETP. A 48% increase for SXL limited partners instead results in an 89% increase for ETP. ETP also benefits when SXL issues more units for growth, as they get a share of a larger total cash pie. As the general partner holder, ETP benefits from this arrangement in much the same way that ETE benefits from ETP.
The structure has exploded in complexity in the last year, but is now showing signs of consolidation as ETE sells its portion of Holdco to ETP. I expected ETE to eventually drop down all of its acquired Southern Union assets to ETP, but the acquisition of Sunoco by ETP complicated the structure, and so that final drop down has been delayed until now.
I envision one of two most probable paths here.
It could be a shift towards ETE once again being a holding entity for other partnerships. In that case, ETP may sell the GP of SXL to ETE, which would result in a simplified structure of ETE holding the GP, IDRs, and a portion of the LP units of the three MLPs: ETP, RGP, and SXL. In that case, ETP, RGP, and SXL would be able to operate fairly independently and offer high current yields while ETE would reap the rewards of the IDRs and offer a great sum of distribution yield and distribution growth.
Another way this could evolve is for the structure to fold itself entirely into ETP. There has been a history on the market of general partners being bought out by the MLP to reduce the drag on distribution growth, with Enterprise Products Partners being the largest example. ETP is the largest compared to SXL and RGP. Like the previous scenario, ETP could sell the SXL GP to ETE. RGC and SXL could merge with ETP, and then ETP could acquire all of ETE so that the structure would then exist as a partnership that can send all cash towards ETP LP distributions.
Regardless of the precise outcome, I expect in the moderate term that we’ll see continued consolidation, some areas of growth, a return to ETP increasing its distribution from a long plateau, and an acceleration of ETE’s distribution growth.
RisksThe largest risks here are the complexity and leverage. Sorting through the financial details of this set of investments takes time and reduces the ability of retail investors to thoroughly invest in the partnership. Each partnership holds debt (currently rated Baa3/BBB- by the major rating agencies), and then ETE also holds parent debt and is rated only Ba2/BB. This leverage has reduced the flexibility of the partnerships, and has played a role in keeping the distribution growth from occurring.
The partnership primarily deals with the transportation of gases and liquids but does have some exposure to commodity pricing. They’re dependent on the health of the U.S. economy and their leverage increases their dependence.
Like other publicly traded partnerships, an additional form is required to be filed during tax season. This generally delays the date in which taxes can be filed by an investor.
Conclusion and ValuationETE and ETP are not the kind of investments that can be purchased and ignored. Much has changed in the last two years, and consolidation should simplify analysis of this structure for next year.
ETP is currently paying a high yield of 7.41% and management has expressed commitment to resuming growth of that distribution. For long-term rates of return to be 9% or 10%, the distribution only has to grow by 1.5-2.5% per year, respectively. It’s the better investment if a high current yield is desired, and I expect ETP’s operations and their SXL holding in particular to allow them to modestly increase their distribution over time.
ETE is paying a more modest yield of 4.28%, but I continue to believe that ETE is in a position to produce higher total returns as this investment consolidates and as the IDRs come back into focus. To produce a 9-10% long-term rate of return, 5-6% distribution growth is required. If SXL continues to increase its distribution, if ETP resumes its distribution increases, and if the partnership continues to consolidate focus on organic growth projects, ETE is in a position to strongly benefit.
It’s useful to recognize the inside ownership in this case. Kelcy Warren, the CEO of the partnership, holds over $350 million of his wealth in ETE and only a small fraction of that in ETP. The same can be said for COO Marshall Mccrea. In addition, Kelcy Warren made multi-million dollar purchases of ETE units in both 2011 and 2012.
Overall, while the market as a whole is highly valued, I observe ETE and to some extent ETP to be reasonably attractive purchases at the current valuations based on their current yields and expectations of mild to moderate distribution growth from consolidation and organic growth.
For further quantitative articles on the partnership, I point readers to these great recent resources:
ETP Turning The Corner Albeit Slowly- Ray Merola
Energy Transfer Fulfilling Its Promise to Simplify- Ray Merola
Further Thoughts on Energy Transfer Holdco Transaction- Ron Hiram
Full Disclosure: As of this writing, I continue to own units of ETE.