Energy Transfer Partners LP (NYSE:ETP) is having a bad month. The price of oil continues to sink, hitting fresh lows for 2017 this week. One of the company’s new pipelines is delayed. Another has opened, but faces ongoing legal challenges. ETP stock has slumped this month due to these concerns.
But it’s not all bad news.
As a result of the June sell-off, ETP stock now yields more than 11%. That’s a great number. And ETP isn’t a fly-by-night MLP; it’s one of the top two players in its sector.
Management has suggested that investors will see large dividend hikes in coming years improving on the 11% yield. Will short-term problems continue to hit ETP stock, or is this the right moment to get involved with the company?
ETP Stock Cons
Rover Pipeline Issues: Energy Transfer Partners has gotten themselves into hot water with their Rover pipeline project. In April, drilling fluids leaked from Rover-related construction into Ohio wetlands. The Federal Energy Regulatory Commission (FERC) began to investigate and shut down parts of Rover’s construction.
ETP’s request to lift the drilling halt was denied. Then, earlier this month, FERC reported that they’d found diesel fuel in the leaked fluids, counter to the company’s claims. Rover was supposed to begin service July 1, a date that now is looking shaky. Further delays could throw off cash flow projections for the year.
Oil Prices Sliding Again: Crude oil, along with other commodities, surged following Donald Trump’s election in November. However, those gains have started to slip. After spending a good chunk of time trading in the $50-$55/barrel range earlier this year, oil has slumped again.
Crude fell to as low as $44 in May and its most recent rebound has petered out, falling to a year-to-date low $43 this past week.
While OPEC’s production cuts initially helped boost sentiment, they’re being overpowered by rising U.S. shale production. That excess supply has continued to weigh on the market. Several recent bearish oil inventory reports have caused oil traders to dump their positions.
Tax Consequences: Consider your tax situation before committing capital to investments in MLPs such as ETP. Consult with your accountant because the tax code works much differently for these types of firms than the C-corp’s which constitute most U.S. stock listings.
Distributions tend to classified as return of capital rather than qualified dividend income. This sort of income is tax-deferred, but lowers your cost basis in a stock. This can lead to unexpectedly large tax bills when you eventually sell your shares. Additionally, MLP owners often end up having to pay state tax in various states where the MLP operates.
Also, a large position in MLPs can cause the IRS to hit the stock holder with the Unrelated Business Income Tax (UBTI). Be aware of these potential issues before investing in ETP stock. This also holds for ETP’s parent, Energy Transfer Equity LP (NYSE:ETE).
ETP Stock Pros
Dakota Access Pipeline Is Live: While Rover has problems, ETP’s other big pipeline overcame its hurdles. The Dakota Access — also known as Bakken — pipeline has generated great controversy. Over the course of the run-up to the pipeline, police arrested almost 500 protesters.
Protests aside, the $4.8 billion pipeline is now operational. The pipeline started operations earlier this month. It will carry almost 500,000 barrels a day and should generate strong stable cash flows supported by long-term contracts with high-quality operators.
Unfortunately for ETP stock, protests and lawsuits continue against the pipeline which could bring fines or operational issues in the future. However, the pipeline is operational, and as they say in the resources business about environmentally-sensitive projects: It’s hard to build something, but once it’s running, it’s hard to stop it.
Anticipated Dividend Growth: Management has told investors that ETP’s dividend will increase by “low double-digits” annually going forward. That’s pretty impressive, given that the annual yield is already greater than 11%. Just seven years of double-digit dividend growth would get ETP’s yield-on-cost to 20% or more by the beginning of 2025.
Do take management guidance with a grain of salt though. Pipeline peer Kinder Morgan Inc (NYSE:KMI) infamously suggested that it’d grow the dividend 10% a year out to 2020, and then slashed its dividend by 75% in late 2015. Unlike Kinder Morgan, however, ETP’s pathway to the promised dividend growth appears much more achievable.
Merger Upside: Investors tend to fear change. ETP stock had suffered from uncertainty. That because ETP was busy merging with Sunoco Logistics. That deal generated controversy, since it resulted in a significant effective dividend cut for investors. ETP stock fell more than 10% in the week following the deal’s announcement.
However, now that the deal has closed, it appears to be a positive for shareholders. Given the troubles that Energy Transfer is having with Rover, and the threat of more headaches with Dakota Access, it’s good that Energy Transfer has another option at its disposal with which to raise distributable cash flow this year.
The combined company — thanks to the merger — expects it to see 2017 distributable cash flow exceed its announced dividend. Analysts doubted the dividend’s sustainability prior to the merger.
In addition, the now-larger company has become a leading player in the midstream MLP space. It ranks #2 in enterprise value, and is at the top of midstream MLPs as measured by EBITDA, based on 2016 results. This scale and the cost savings from merger synergies may reposition the company’s credit, giving it a path to a credit rating upgrade.
At 52-week lows, ETP stock certainly seems exciting. The market isn’t offering many 11%-yield stocks these days; even fewer where management has suggested that the yield will rise at a double-digit rate in coming years. If management delivers, ETP stock will deliver fantastic returns.
However, with high yields also come high risk. Energy Transfer’s new pipelines face significant opposition. Dakota Access is up and running, but there are still lawyers fighting it on multiple fronts. Rover could face significant delays. While the Sunoco Logistics merger helps support the dividend, the combined company could come under fire if the price of oil keeps dropping and legal/environmental problems continue.
As of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.