Best Stocks for 2020: Energy Transfer Stock Has Been Here Before

Editor’s note: This column is part of our Best Stocks for 2020 contest. Charles Sizemore’s pick for the contest is Energy Transfer (NYSE:ET).

ET stock has been here beforeAs I sit down to write this, my pick in’s Best Stocks for 2020 contest — pipeline giant Energy Transfer (NYSE:ET) — is smack-dab in last place and nursing losses of over 60%.

I’m not too thrilled about that, as you might imagine. But we’ve been here before.

In the Best Stocks for 2016 contest, Energy Transfer was my pick. It struggled at first, and toward the end of the first quarter I was down more than 70%.

But then, a funny thing happened. The stock finally hit bottom and proceeded to rocket higher. I finished the year with a 53% return.

Now, history never repeats itself exactly. I have no idea if ET stock is going to mount an epic rally over the next nine months of 2020. But I know that, given the stock’s valuation, it very easily could.

What Happened to ET Stock?

Master limited partnerships (MLPs) like Energy Transfer have been mostly out of favor. And there’s several reasons for this. To start, many conservative income investors that bought them for the yield got burned badly in 2015 and 2016 when the price of crude oil collapsed. Many MLPs proved to be a lot more sensitive to energy prices, and several had to cut their distributions. (Energy Transfer did not, by the way).

But even those that were relatively unaffected by falling crude oil prices were found to be over-leveraged and far too dependent on the whims of the bond market.

At any rate, large swaths of the investing public swore off the sector and never returned.

So, the sector was already in need of some love, and then a double whammy hit it. The coronavirus from China knocked most stocks deep into bear market territory. And if that wasn’t enough, Saudi Arabia effectively declared economic war on Russia and American shale producers. That provided further punishment to energy stocks and ET stock.

Today, there is legitimate concern that a wave of bankruptcies will slam the American oil patch. And there is additional concern that the bankruptcies could change Energy Transfer’s pipeline contracts.

The uber-bear case is that domestic storage of crude oil is filling up rapidly and, once at capacity, will force the price of crude oil to literally zero or even below zero in the short term. This could lead to Energy Transfer’s partners triggering force majeure clauses in their contracts. These clauses would allow them to potentially reduce or skip payments.

Even though Energy Transfer’s revenues are 85%-90% fee based, this hard-to-quantify risk is hanging over ET stock.

What Now?

I’d start by noting that Energy Transfer’s management seems unconcerned. These are swaggering oil men accustomed to taking risk, so we should probably take their boldness with a healthy grain of salt. And events are unfolding so quickly that it is possible management simply hasn’t thought through all contingencies yet.

But company insiders have snapped up about $18 million in ET stock in the month of March alone. And this is after founder Kelcy Warren dumped about $90 million into ET shares in February.

Again, it’s possible that the situation in the oil patch is deteriorating faster than management thought at the time of their insider purchases. We’re not privy to that information. But I do take comfort in the fact that management is heavily invested in the stock and has every incentive to hunker down and get through this.

One of the criticisms of Energy Transfer over the years is that management has been too obsessed with growth, sometimes taking cavalier risk in the process. That’s probably a fair statement. But management has indicated it’s considering putting around half a billion in planned capital expenditures on hold for the remainder of this year.

And in 2021 and beyond, the company highlighted “flexibility to adjust long-term capital plans.”

That’s good. It shows that management is willing to conserve cash in the short term as a precaution.

Furthermore, it’s worth noting that ET has no major debt maturities this year and minimal maturities next year. The company carried more debt than some of its more conservative peers, but thankfully none of it needs to be refinanced for a while.

Lastly, 71% of Energy Transfer’s counterparties are rated investment grade. The remaining 29% that are not rated investment grade are spread out across more than a thousand smaller operators.

The Bottom Line on ET Stock

If Energy Transfer sees some of its counterparties stop paying, it will almost certainly have to temporarily reduce or eliminate distributions. I should repeat that I consider this an unlikely scenario.

But then, I would have also viewed a global pandemic and Saudi-Russian price war to be unlikely as recently as two months ago. We have to consider things previously considered unthinkable.

Should the worst happen, you can bet that management would do whatever it had to do to get the distributions restarted in short order. Their own livelihoods depend on it.

I’ll repeat again that I see this scenario as unlikely. But I also believe this is the scenario currently being priced in. At this point, ET stock is essentially priced for the absolute worst-case scenario. If anything short of that scenario happens, I expect the shares to go on a truly epic run.

Will it be enough to take the 2020 Best Stocks crown?

We shall see.

As of this writing, Charles Sizemore was long ET. 

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