Editor’s note: This column is part of our Best Stocks for 2016 contest. Charles Sizemore’s pick for the contest is Energy Transfer Equity LP (ETE).
This year didn’t get off to the start I had hoped for with Energy Transfer Equity (ETE). My pick for the 2016 Best Stocks contest puts me smack dab in last place. Shares of Energy Transfer are down by nearly half, even after taking the high dividend into account.
Sigh…
Well, I hate losing money, even if it’s a short-term unrealized loss. But the good news is that I expect Energy Tranfer Equity to finish this year well into positive territory. And over the next 3-5 years, I believe ETE stock is one of the few large-cap stocks that really offers the potential to be a five-bagger (i.e., a stock that increases in value by a factor of five).
Above: It’s been a rough ride for ETE stock owners in 2016
I’ll get into why I still believe that ETE is a fantastic stock for the remainder of 2016. But first, let’s look at some of the factors that have sent this stock into a tailspin.
- Falling crude oil prices: Energy prices have stabilized… for now. But for most of 2016, the price of crude oil was in free fall. This hurt the share prices of virtually all energy companies… and ETE was no exception.
- CFO left under mysterious circumstances: For reasons that were never fully explained, CFO Jamie Welch left the company in early February without any warning. It now appears that he was fired (Welch has subsequently sued ETE for his termination). Firing the CFO in the midst of a difficult merger with Williams Companies (WMB) spooked shareholders… and sent the stock down 40% in a day.
- Major uncertainty about the merger: And speaking of the merger, investors have gotten more and more skeptical of the deal and particularly of the $6 billion cash component. The sentiment has become that the Williams deal — and the debt that would come with it — is a bad deal for Energy Transfer Equity shareholders.
- Odd moves by management: Without any prior notice, Energy Transfer Equity converted the common units owned by several large insiders — including founder and chairman Kelcy Warren — into convertible preferred shares.
This last point needs a little more explaining. As a way of conserving cash to finance the merger with Williams, Energy Transfer Equity converted nearly a third of its common units into preferred stock units that will receive a quarterly distribution of $0.11 per unit, which is about 40% of the current common distribution, for as long as nine quarters. In exchange for foregoing 60% of the current cash distribution, the preferred unit holders will get paid back all of these missed distributions in new common units… at a sweet price of $6.56 per share.
The move by ETE was ostensibly to immediately free up cash for the merger. But a cynic might see something more underhanded going on here. Mr. Warren and his inner circle have effectively jumped ahead of regular investors in the capital structure. Preferred stockholders get paid before common stockholders. So… if ETE stock were now to slash its regular common distribution, Warren and the other preferred unitholders would still hypothetically get paid.
Now, I don’t expect that to happen. I’m not necessarily the trusting sort, but I wouldn’t expect Warren to risk the inevitable lawsuit and regulatory scrutiny that would ensue if he were slash the common distribution and keep the preferred distribution intact for wealthy, connected inside investors. With all of the popular anger towards Wall Street insiders these days, I don’t think he could get away with it. Nor do I think that was his intention. But I agree with the cynics that the deal didn’t quite smell right.
In a press release, Energy Transfer Equity essentially blamed Williams Companies. In a nutshell, ETE said that it intended to make the deal available to all shareholders, but this required approval from Williams that Williams wasn’t willing to give. So the only option they had left was to do a private offering to “certain accredited investors.”
In another interesting twist, ETE came out with revised expectations of the value of the Williams deal, slashing its projected synergies from $2 billion to just $170 million. ETE also indicated it would be diluting Williams shareholders with a stock incentive plan to employees and that it would be shutting down most of Williams’ presence in Oklahoma.
It almost looked as if all of these recent moves were designed to infuriate Williams shareholders into killing the merger. We’ll never really know, of course. But this is not really the sort of behavior I want to see in a company I own.
So, if I’m not thrilled with some of management’s recent behavior, why am I still so bullish on the stock?
Let’s start with the basics. Whether the Williams deal happens or doesn’t happen, ETE is still at the top of durable energy empire. ETE controls Energy Transfer Partners (ETP), Sunoco LP (SUN), and Sunoco Logistical Partners (SXL) and collects incentive distribution rights for its efforts. ETP is in a bit of a soft patch right now and may not be raising its distribution. But some of its major growth projects should start cash flowing next year, and distribution growth should follow. Meanwhile, Sunoco and Sunoco Logistical Partners have both continued to raise their dividends at impressive clips. SUN’s last distribution was 33% higher year over year, and SXL’s was a good 20% higher.
So whatever happens with Williams, Energy Transfer Equity’s cash flows are supported by a strong collection of MLPs feeding into it.
This brings me to the distribution. At current prices, ETE stock yields an absurd 16%. Six months ago, I would have told you that distribution was absolutely sacrosanct. But as we saw with Kinder Morgan (KMI), distributions can and will be cut when an MLPs credit rating is on the line. That said, I think that ETE will probably muddle through without having to cut its distribution. Given the current yield of 16%, a dividend cut is already effectively priced in. So while there would still be further damage to the stock price if the dividend got axed, most of the pain is already priced in.
ETE was cheap at $15 per share. It’s downright ridiculous at $7 and below.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. He is long ETE.
