What a year. When I chose controversial pipeline operator Energy Transfer Equity LP (NYSE:ETE) as my pick in the InvestorPlace Best Stocks for 2016 contest, I knew it would be a wild ride. But I certainly didn’t expect it to be this wild.
At one point in the first quarter, I was down over 70% on this recommendation … and placed in dead last. But after a run that saw ETE jump over 300% off of its lows, I’m now in a solid second place … and there is still another quarter left to go.
As of Oct. 10, Motley Fool Senior Analyst Jason Moser’s pick — mortgage servicing software maker Ellie Mae Inc (NYSE:ELLI) — is leading the pack, up a whopping 75% in the first nine months. Energy Transfer was in second place, up a more modest 22%. And Jon Markman, editor of Trader’s Advantage, is in a respectable third place with Globant SA (NYSE:GLOB), up 12.3%.
But of the lot of them, I see Energy Transfer as having the most upside potential for the remainder of this year.
Let’s dig into the details. To start, Energy Transfer is a cheap stock in a cheap sector. About this time last year, all hell broke loose in the master limited partnership market. Kinder Morgan Inc’s (NYSE:KMI) dividend came under pressure, and the MLP sector proceeded to lose about 40% of its value over the following four months before finally bottoming out in February.
ETE Stock and the Problems for MLPs
As a sector, MLPs are now within about 10% of new 52-week highs. But they’re still down about 35% from their all-time highs set back in 2014. In fact, even after the run this year, the sector is sitting at early 2010 levels.
It may be years before MLPs see their 2014 highs again. With the domestic drilling industry still suffering from low oil and gas prices and overcapacity — and with pipelines facing renewed political pressure from environmentalists and Native American groups — the sector should be cheaper than it was two years ago.
That said, we still have a long way to go before we reach those levels.
Energy Transfer trades for 13.4x its distributable cash flow, which is far below its average of 24.7x over the past ten quarters. It also yields a fat 7.2% in dividends, which is roughly double its pre-energy-crash levels.
Now again, some of this discount is justified. ETE is a highly leveraged company at a time when banks are skittish about lending to the energy industry. And the higher yield reflects lower prospects for distribution growth. Prior to the energy bust, it wasn’t unusual for Energy Transfer Equity to raise its distribution by 30% or more in a year, and as recently as a year ago, management was forecasting distribution growth of 20% or more for per year for several years to come.
Well, with the Williams Companies Inc (NYSE:WMB) deal falling through, that’s not happening. In fact, most analysts expect the distribution to remain flat for at least another couple years as ETE works on bringing its debt load down to size.
But again, even with no distribution growth, a 7.2% yield is something that will get your attention. And growth will return, even if we have to wait for it.
As for the here and now, the biggest issue pressing ETE is the political opposition to its Dakota Access Pipeline. Recently, a federal appeals court gave the go-ahead to ETE to resume construction, which had previously been halted by court order. But the Obama Administration is still opposed to the project, and there is the risk that this turns into another cause célèbre like the protests over the Keystone Pipeline. We’ll see.
But the completion of the project could be exactly the catalyst this stock needs to take the crown in this year’s Best Stocks contest.
Charles Sizemore is the principal of Sizemore Capital Management. As of this writing, he was long ETE and KMI.