Energy Transfer Is Doing Just Fine

Dear fellow Investors:

Last night’s Energy Transfer LP (NYSE:ET) conference call for Q2 earnings was, at first blush, a bit disappointing to me, not so much because of the small performance miss due to lower natural gas (“NG”) and NGL pricing (versus last year’s super robust prices), but because of the things I heard on the call versus the things I wish I had heard.

For some time, we have been watching ET management discuss how they were focused on reducing debt leverage as they seek a credit upgrade. For some time, we have been listening to management discuss how they are imposing strict criteria to any new project or acquisition they consider, suggesting everything will have to help ET deleverage while also being accretive to cash flow.

Last night, the first time I listened to the Conference Call, I felt a change in tone that disturbed me a bit. Management mentioned a few of the items I was looking for, but spent more of the time justifying their enthusiasm for growth. This made me feel a bit unsettled.

I didn’t have a problem hearing that ET was boosting capital expenditure expectations to $2 – $3 billion annually, but I didn’t like hearing management suggest that they really wanted to do at least $3 billion. Sure, I love the idea of $3 billion in new investments generating 13% returns, allowing ET to grow EBITDA by roughly $400 million per year, but what I really wanted to hear was how ET was going to let balance sheet leverage drop below 4.0x (in my dreams). I felt that management’s desire to grow conflicted with the way I might manage the company if I was in fact the King or CEO.

Management expressed confidence and self satisfaction with their recent acquisitions, they even suggested the Enable deal was operating far above their S4 prior expectations, over 45% better in fact. Management also sounded very confident that the more recent Lotus deal was also going to greatly exceed prior plans. But while hearing these glowing remarks, I couldn’t help but feel that one or two recent deal successes certainly do not tell the whole story. I felt I’d rather have heard more about a humble desire to pay down more debt and raise the distribution on the units faster.

Feeling grumpy and unsure, I decided to listen to the call a 2nd time and take more notes. Early on, I realized that management did in fact explain that they were driving the leverage down to the “lower level” of the 4.0 to 4.5 range. This was new. Previously, management always emphasized that they wanted to reach this range and then reconsider what to do next. Now they were more or less committing to the 4.0x level. Then, later in last night’s call, when asked about whether they would allow the leverage ratio to rise above the 4.0 to 4.5 range if an attractive acquisition required it, management said “no, they did not intend to allow the ratio to rise above this range” (more or less, I paraphrased).

Then I listened more closely to their discussion about Lake Charles and the LNG opportunity. While determined to do everything they can to move the project forward, management made it clear they do not intend to invest nor own more than 25% of the equity in the project (same as prior statements in the past). In fact, they emphasized that they already had lined up two very large equity investors eager to own the majority of the project. My mind went back to prior conversations where management also had said their 25% equity would include the assets and land at Lake Charles which ET would contribute to the deal.

Thus, if the project ends up costing about $12 billion and ET expects to own 25%, then ET might need to invest $3 billion during the time frame required to build the facility. But possibly half or a third of their $3 billion might be counted on as the assets and land already constructed at Lake Charles site, so in truth, this project may only cost ET about $1.5 to $2 billion while the finished project would be a hugely valuable contribution to the entirety of the company. Mgmt’s comments last night made sense and I started to relax as I began thinking about the numbers further.

With management’s EBITDA guidance for 2023 staying at roughly $13.25 billion for the full year, I suddenly realized “again” that ET management was excited about growth and might have good reason to be, but they also were taking for granted that we investors all understood that ET was generating SO MUCH cash flow that they surely were not going to issue any new debt to build new projects, the $2 to $3 billion in annual capital expenditures going forward can all be funded internally with cash. With $13.25 billion in EBITDA generated during a year in which NG prices and NGL prices were down 40% to 70% from the prior year, suddenly I realized these numbers suggest ET may easily continue to generate more cash flow than they can deploy. I began to wonder what ET might generate in the future if prices and margins lifted partially back to higher healthier levels? Maybe ET could keep paying down debt and continue to grow at a nice clip? Maybe I really am going to get growth and a stronger balance sheet all at the same time?

Laying in bed, I couldn’t help myself from reviewing the numbers. If ET generates $13.25 billion in EBITDA this year and $2.0 billion of that EBITDA is associated with their partial ownership of USAC and SUN, and $3.1 billion is used up servicing debt and maintenance expenses, then 13.25 -2.0 -3.1 leaves us with $8.05 billion to pay the distribution and invest in new projects or deals. With 3.1 billion units currently paying $1.24, that costs ET about $3.9 billion so ET still has about $4.2 billion to invest or spend on whatever they think is wise. I reminded myself that ET is generating this sort of huge cash flow in spite of the lower margins associated with the crash in NG and NGL prices which took place here in early 2023.

Given that ET has expressed an interest in investing up to about $3 billion per year in new capital expenditures, that leaves management with $1.2 billion to pay down debt, buy back units (not likely), grow the distribution, or simply hold on to as a safety buffer. In other words, nothing has changed. ET is still internally funding their growth projects and continues to expect to generate enough cash flow to continue to reduce the debt leverage by about $1.0 billion a year if it happens to make sense to do so along the way. I should be pleased.

I finished my thoughts on Energy Transfer LP thinking that today some investors may knee-jerk sell the units, but I realized that nothing has changed, this company is living within its means, it is seeking a credit upgrade, and it is demonstrating the sort of self discipline we need to see. The fact that management is also bullish on hydrocarbons and opportunities to dominate exports of light sweet oil, ng and ngls out of the GOM, well that certainly all makes sense to me too. 70% of the world is energy deprived and hungry for far, far more hydrocarbons than they currently consume. Energy Transfer LP is right, they do have enormous growth opportunities and as long they avoid using new debt and higher leverage, then the enormous dividend yield and the 3% to 5% growth management is pursuing seems rational, compelling and fine by me.