I understand why investors may be interested in buying shares of Energy Transfer (NYSE:ET). In a volatile market, ET stock has an eye-popping dividend yield of 14.73% as I write this article. But one person’s eye-popping is another person’s eyebrow raising. The latter describes my reaction to Energy Transfer’s juicy dividend. It’s one reason to buy the stock. But is it enough?
The thing about a dividend yield is that it’s a poor way to test the strength of a company’s dividend. You have to look closely at the fundamentals of the stock. This will help you understand whether the dividend is secure not only today, but in the future. And that’s what many value investors really want in a dividend stock.
I’m not sure if those conditions exist for ET stock. Allow me to explain why.
Energy Transfer Has a Safe Dividend
First, I’m not saying ET stock is a dividend trap. The company is a master limited partnership (MLP). As such, they’re required to pay out a significant portion of their earnings as a dividend. Right now, the company pays out just over 84% of its earnings as a dividend. Mark Hake wrote an insightful article explaining why the dividend is well supported by the company’s distributable cash flow (DCF).
But remember, chasing a dividend yield can be fool’s gold. Energy Transfer has an uneven history of issuing dividend increases. On the one hand, it gave investors two dividend increases in 2017. But prior to that, the company had not issued an increase in two years.
This simply means that the reason the dividend yield is going up is because the share price is going down. For example, almost a year ago, ET stock was trading at around $14 per share and the dividend yield was almost half of what it is now.
While that’s still impressive, it’s a reminder that dividend yield is not the most important factor to consider. Value investors are looking for companies that increase their dividend on a consistent basis. That has not been the case with Energy Transfer.
A Dividend Is the Only Reason to Buy ET Stock
However, when it comes to Energy Transfer at the moment, a dividend isn’t just the best reason to buy the stock. It’s the only reason. This is because the company’s growth is dependent largely upon the price of oil, which remains an iffy bet in 2020. Oil has gotten up off the mat. But let’s be honest, we expected that. The decrease in demand was due to an unprecedented destruction due to the global effort to curb the spread of the novel coronavirus.
Oil stocks, and those related to it like ET stock, are historically seen as good defensive stocks. In addition to a dividend, demand is always seen to be relatively stable. But demand is not stable right now. Millions of Americans are still working from home. A recent Gartner survey of chief financial officers (CFOs) revealed that approximately 17% expected at least 20% of their employees to continue working from home after the pandemic ends.
But that’s not where the demand constriction ends. Business travel in the age of Zoom (NASDAQ:ZM) is sure to be less than before. And when it comes to leisure travel, it’s hard to say. While there is clearly pent-up demand, it remains to be seen if families are willing to take a Disney (NYSE:DIS) vacation that will be challenging at best. Even fans that want to watch live sports will have to do so in front of their televisions for the foreseeable future.
The bottom line is that until there is a vaccine or significant treatment for Covid-19 and the underlying novel coronavirus, there will be pressure on oil prices. And that does not bode well for oil stocks or oil-related stocks.
Will Energy Transfer Cut Its Dividend?
However, there is more to consider than just the ability of a company to pay its dividend. A very real concern raised by Ian Bezek is the company’s ability to sustain its dividend in the future. Among other things, Bezek points out that the company recently had their credit rating lowered to BBB-. That’s one step above junk status.
If the company were to fall to this level, it will be much harder for the company to service its debt, which may leave them no other option but to cut its dividend.
Without a Better Outlook for Oil, Energy Transfer Is Not a Buy
I’ll admit that the ET stock dividend is attractive. And the company is likely to maintain that dividend at least for the rest of 2020. But looking beyond this year, Energy Transfer has to make good on plans to trim its capital budget. On the call from the most recent earnings report, CFO Tom Long said he “fully expected the company to be free cash flow positive in 2021 after growth capital and equity distributions.”
But if demand doesn’t improve, then it’s possible the company will have to reduce its dividend to reduce its debt. And that would make the dividend less attractive.
It’s possible that Energy Transfer will be able to thread this needle. And if you have a high risk tolerance, a dividend yield of over 14% is attractive. But I like my dividend stocks with less risk, which is why I advise taking a pass on ET stock.
Chris Markoch is a freelance financial copywriter who has been covering the market for over five years. He has been writing for InvestorPlace since 2019. As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
