Energy Transfer Partners LP (ETP) Is a High-Risk Contrarian Buy

Editor’s Note: This article initially named the incorrect company with which ETP had merged.

If you like contrarian plays, Energy Transfer Partners LP (NYSE:ETP) is for you. ETP stock (or LP units, as they’re technically known) has fallen roughly 70% from late-2014 highs. The news for the ETP stock price of late has been even worse. ETP has declined 23% year to date, with a 21% decline just over the past month.

Energy Transfer Partners LP (ETP) Is a High-Risk Contrarian Buy

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That would seem to create an opportunity. Energy Transfer Partners LP’s controversial Dakota Access pipeline is now online. The Rover pipeline in Ohio is dealing with regulatory issues, but will start flowing soon as well. The April merger with Sunoco Logistics Partners led to a de facto distribution cut. But, management has guided for double-digit increases going forward — of an ETP stock distribution already yielding more than 10%.

There are substantial risks here, however. ETP stock is a classic “falling knife.” Energy Transfer Partners LP continues to have regulatory and environmental problems. The issues in Ohio and North Dakota are part of a long-term pattern. ETP’s debt remains high.

And, its distribution coverage ratio rose above 1.0x thanks to the Sunoco merger. But, that may recede if new projects don’t get off the ground, or if disappointing Q1 results repeat over the rest of the year.

Still, there’s enough here to see a buying opportunity — for investors with a very high risk tolerance. Energy Transfer Partners, LP isn’t a play for traditional income investors. But, those willing to try and time the bottom and bet against market sentiment should take a long look at ETP stock.

Why Investors Should Run Screaming From Energy Transfer Partners, LP

The former Energy Transfer Partners LP struggled after the peak of the shale boom in late 2014/early 2015. ETP managed to hold its distribution steady, but investors chasing that distribution saw greater losses from the decline in the ETP stock price than they received in income.

Indeed, ETP was going to have to cut its dividend at some point, as even management admitted in its merger presentation. A 15%-25% cut would have been required to keep the debt-weighted Energy Transfer Partners LP balance sheet within lender covenants. The Sunoco merger created an effective 24% cut itself on a per-unit basis.

That merger has helped the balance sheet, but it hasn’t cured ETP’s problems. Pro forma figures from Q1 still suggest a 6x+ leverage ratio for the combined entity. In some ways, Energy Transfer can seem like an MLP version of Valeant Pharmaceuticals Intl Inc (NYSE:VRX), a company that over-leveraged into a declining business.

And, there are still questions about the sustainability of the ETP distribution. ETP general partner Energy Transfer Equity LP (NYSE:ETE) has waived its incentive distribution rights. Without that waiver, Energy Transfer Partners LP still would have a distribution ratio under 1.0x. Either ETP has to grow profits, or cut the distribution. And, the lack of growth in Q1 — pro forma adjusted EBITDA was flat — suggests that profit may not rise to the level management projected.

Meanwhile, there are regulatory issues in Ohio, a long-running problem for Energy Transfer Partners LP. Q1 numbers showed weakness in the Midstream segment in Texas. A new court ruling could threaten the Dakota Access Pipeline, or at least change its route. There are plenty of short- and long-term reasons to run away from ETP stock.

Why ETP Stock Is Worth the Risk

But, there are also reasons for optimism. ETP doesn’t have direct exposure to plunging oil and gas prices, for one. (Obviously, if lower prices mean lower production, that would hit Energy Transfer Partners LP revenue and profit.) And, there is room for volume growth between Rover and Dakota, plus the pending acquisition of Penntex Midstream Partners LP (NASDAQ:PTXP).

Short-term regulatory risk aside, the political environment under the Trump Administration still should be rather benign for ETP and the producers it serves.

The Sunoco-ETP merger still has benefits to play out. And, while ETE’s IDR waiver is temporary, as general partner ETE has both the incentive and the wherewithal to paper over other short-term problems.

There is real value in Energy Transfer beyond the headline distribution. It’s now the second-largest midstream MLP, according to its merger presentation, behind only Enterprise Products Partners L.P. (NYSE:EPD). Oil prices, in particular, are plunging. But, U.S. production is holding up, and cost-reduction efforts by producers such as Chesapeake Energy Corporation (NYSE:CHK) and Sanchez Energy Corp (NYSE:SN) mean those producers can survive a “lower for longer” scenario in crude.

Overall, there are risks here. But, ETP stock is pricing in an awful lot of trouble already, including, likely, a dividend cut.

As InvestorPlace pointed out this week, a high yield generally implies high risk. That’s the case with Energy Transfer Partners LP, as well. But, high risk doesn’t mean “run away,” either. And, investors willing to be patient and ride out some volatility could see big rewards for the current risk priced into ETP stock.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

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