Energy stocks are still treated like pariahs as the world continues to grapple with the disastrous effects of the novel coronavirus. Although Energy Transfer (NYSE:ET) stock hasn’t recovered a lot of lost ground, long-term prospects for the energy giant remain excellent.
The midstream company has enough funds to cover its attractive payouts, even though the management is not putting the brakes on pursuing growth. Its cheap valuation, strong dividend yield, and healthier free cash flows convince me ET stock is in fine stead for the future.
Dividend Yield Is the Best Among Its Peer Group
With a dividend yield of 16.1%, Energy Transfer is far and above the leader in its peer group. Although there is concern regarding whether or not the company can maintain this dividend in the current environment, I find those fears unfounded. Free cash flows did fall in the first quarter, but that’s understandable. At a time when oil prices are so low, you wouldn’t expect operating cash flows to rise sequentially.
And while there is a lot of talk on pent-up demand that will unleash in the next couple of months, the truth is that all signs point to a slow recovery. Oil demand in India and China rebounded from record lows during the lockdown. But they are still substantially down from levels before the crisis.
Meanwhile, OPEC+ and Russia remain at loggerheads on production cuts, further depressing prices.
Then why didn’t Energy Transfer report lackluster earnings in the first quarter? Well, the answer lies in the fact that a majority of its income is fee-based. As oil prices continue to recover, the portion dependent on oil demand will rise as well. Due to its earnings mix, I don’t foresee a sharp decline in cash flow or profitability in the forthcoming quarters.
Debt Is High, But Not Out of Control
Liquidity is a key issue for every energy company at this point since we don’t know when energy demand will bounce back to pre-pandemic levels.
At the end of the first quarter, Energy Transfer had long-term debt of $50.3 billion, down by $0.7 billion sequentially. Despite that, the company is the most indebted within its peer group.
However, the company is actively slashing operating expenses and capital expenditures, which should free a considerable amount of cash it can use to deleverage. ET expects to generate between $11 billion and $11.4 billion of adjusted EBITDA this year. It is also committed to maintaining a debt-EBITDA ratio of 4 to 4.5. If you combine those two factors, we can hope to see a sizeable deduction in debt this year.
A Second Wave Will Be a Sizable Roadblock for ET Stock
Several U.S. states have reopened as Covid-19 linked fatality rates continue to fall. That’s a good sign for the economy, but experts are warning that a second wave of the pandemic could be imminent if we don’t take greater caution.
Share prices have made a lot of ground in the past three months. But all that could go down the drain if we have another wave of cases.
Final Word on ET Stock
Energy Transfer weathered troubled waters ably and is well-positioned to ride out this crisis. Although the company’s free cash flows fell sequentially in the first quarter, I expect it to mount a recovery in the forthcoming quarters.
Looking ahead, Energy Transfer is looking to spend approximately $2 billion annually on future projects. At a time when most companies have suspended their capex programs completely, Energy Transfer is looking to go down a different route.
Meanwhile, the company’s dividend yield is attractive and is the best among its peers. It has the resources to maintain its distributions but can also slash its dividend to pay down debt. Shares are also attractively priced, trading at a price-earnings ratio of 11 times, a 16.9% discount to the sector.
I am bullish on ET stock. Retain the stock if you have it in your portfolio. If not, then buying a small stake will not hurt.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. He does not directly own the securities mentioned above.