Energy Transfer (NYSE:ET), the midstream natural gas pipeline and gas gathering company, has an attractive 14.9% distribution yield at today’s price. ET stock, at just over $8 per share, should be trading much higher than it is.
Over time, as the price of natural gas starts to improve with the economy, the stock will move up.
The distribution has been kept at 30.5 cents per quarter ($1.22 per -annum) for the past two-and-a-half years. At today’s prices, this gives ET stock a 14.95% distribution yield.
Energy Transfer produced results that showed that its high levels of distributable cash flow (DCF) more than cover the costs of its quarterly distributions to partners.
DCF and Distributions
On May 11, the company produced good results for Q1. For example, a key measure that energy distribution companies use is DCF. DCF is EBITDA (earnings before interest, depreciation, and amortization) less maintenance interest and capital expenditure costs.
For example, the company said that its DCF for the quarter was $1.417 billion. The dividend distribution, at 30.5 cents per share, cost just $822 million. That means DCF covers the distribution costs by a ratio of 1.72.
Moreover, the company also said it plans on reducing capital spending. That helps keep the coverage ratio high, even if the price of natural gas continues to drop. Energy Transfer said it would lower its capex costs by $400 million. In addition, another $300 to $400 million could be cut out.
DCF will rise by up to $800 million, depending on what happens to the price of natural gas. In effect, it acts as a buffer, or a sort of margin of safety if the price of gas doesn’t increase as economic activity rises.
What ET Stock Is Worth on a Normalized Basis
One way to estimate the value of ET stock is to compare it with the historical distribution yield. For example, Seeking Alpha has a page on the stock showing that the four-year average yield has been 10.5%.
Therefore, taking today’s annualized distribution per share of $1.22, and dividing it by 10.5%, yields a target price of $11.62 per share. That means the stock, on a normalized basis, should be trading at least 42% higher.
Even assuming that at least half of that “normalization” will occur by the end of the year, as economic activity picks up, puts ET stock on a value of $9.89 per share.
The company has not even broached the subject of cutting or lowering its distribution costs. Therefore, I think this is a good target price for ET stock.
Factors Affecting Natural Gas Prices
The US Energy Information Administration says there are three factors that affect natural gas prices:
- Variations in winter and summer weather
- Level of economic growth
- Availability and prices of other fuels.
The EIA does not say which factor has greater sway. I suspect that now, however, the major factor will be the pickup in economic activity between now and the end of the year. This will be highly influenced by the availability of a Covid-19 vaccine.
Nevertheless, as CNBC reports, the price of oil, which highly influences natural gas pricing, has been picking up.
What to Do With ET Stock?
I suspect that Energy Transfer will continue to do well through the end of the year. Its cash flow should begin to bottom out and start to rebound. That will make its high distribution yield much more secure.
Look to buy ET stock on dips in the market, and on days when the price of oil and gas falter.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.
