Energy stocks have had a volatile year, and Energy Transfer (NYSE:ET) stock has been no exception. The pipelines and energy infrastructure company saw its shares plummet from a 52-week high of $15 to just $4 in March.
However, shares surged back to $9 recently, as investors feasted on its huge dividend and improved prospects as oil and natural gas prices bounced.
Over the past week, however, the momentum has reversed itself yet again. Energy Transfer is trading sharply lower following news that one of its key pipelines may have to shut down in the near future. That, in turn, threatens the company’s already overextended balance sheet.
Up until now, Energy Transfer has resolutely refused to cut its dividend despite the oil and gas bust. With the stock yielding an astounding 19%, however, and a key cash flow driver set to go idle, it looks like it’s the end of the line for Energy Transfer’s oversized yield.
Income investors should plan accordingly while there is still time to act.
Losing Access to the Dakotas
Earlier this week, the U.S. District Court for the District of Columbia ruled that the operators of the Dakota Access Pipeline must suspend operations within the next month. This is a surprising ruling, as the Dakota Access Pipeline has already operated for three years.
In general, with infrastructure projects, it’s hard to get permits and construction done in the first place. However, once it’s running, usually the government doesn’t try to shut things down.
However, there are exceptions to the rule, and Energy Transfer now finds itself in a bind. Energy Transfer is the largest stakeholder in the Dakota Access. ET stock is down 10% in recent days, and other companies that have a stake in or rely on the Dakota Access Pipeline have also slumped.
The pipeline has been a vital piece of equipment for the Bakken oil field. It gave access to the relatively stranded oil production assets in North Dakota, allowing them to fetch a fair price from far-away refineries. Without it, much shale activity in the area could be rendered uneconomic.
As such, Energy Transfer seemingly had a high-value asset in the Dakota Access; in fact, despite the outstanding legal questions, the company had wanted to add more capacity to the pipeline. In theory, it should be a high-earning asset. Now, though, a court may render all this moot.
A Worrisome Debt Feature
Even after the Dakota Access pipeline went into effect, investors knew that there were legal risks out there. A Native American tribe had opposed the pipeline and didn’t drop their case even after the pipeline opened.
Many investors assumed that the legal risks wouldn’t be too severe, given the Trump Administration’s pro-fracking policy. However, an individual court can buck the party line, as happened in this case.
Here’s where things get messy. The Dakota Pipeline operators took out $2.5 billion in debt last year. In doing so, they agreed to backstop the debt in the event that a court shut it down. As a result, Energy Transfer, which owns 38% of the pipeline, may have to kick in as much as $1 billion to pay off the bondholders of the soon-to-be-idled asset.
To give a sense of perspective, Energy Transfer paid out $3 billion in dividends last year. That was more than the $2.8 billion that it earned in net income. Now income will drop as it loses cash flows from the Dakota Access for a time period.
Meanwhile, trimming the dividend by a third, reducing the yield to a still juicy 13%, would free up $1 billion per year thus covering the hole from the potential Dakotas legal liability.
One Positive: Berkshire Is Buying Pipelines
Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A,NYSE:BRK.B) announced that it is making a nearly $10 billion deal. It will be buying more than $4 billion in natural gas pipelines along with assuming more than $5 billion in associated debt. Dominion Energy (NYSE:D) is the seller.
This is interesting for Energy Transfer investors on several fronts. For one, Dominion had been trying to get bigger in the pipeline space. It sought to build an $8 billion Atlantic pipeline system but was blocked by environmental and regulatory concerns. Now, instead, Dominion has cancelled the Atlantic project, and sold much of its existing natural gas assets to Berkshire.
Two, Berkshire’s purchase signals that natural gas pipelines are still a good industry. Increasingly, folks have avoided pipelines and master limited partnerships (MLPs) because of poor returns and a questionable long-term outlook for the industry. However, Berkshire’s move validates the space in general, as there is still a high-quality firm willing to buy assets in the space.
ET Stock Verdict
For the long haul, I remain skeptical on ET stock. I’m not convinced that it will be able to maintain its abnormally high dividend indefinitely. Management has a tendency toward empire-building. However, the energy bust has instead rewarded companies that have kept a tight leash on expenses and managed their cash flow adeptly.
Energy Transfer simply wasn’t designed for the sort of prolonged downturn that we’re seeing. And now, they are at risk of losing a major piece of their cash flow due to the Dakota Access legal mess.
As a result, a change in corporate strategy is quite likely. That could include asset sales or a major dividend cut. With those possibilities looming, I’m not thrilled about buying Energy Transfer as an investment here.
However, purely as a trade, ET stock could work in the short run if the company gets a favorable resolution on the Dakota Access issues. MLPs are undoubtedly in the dumps as far as sentiment goes. Traders already hated the sector coming into 2020, and then things went from bad to worse in March.
Buffett’s big splash in the midstream space could finally trigger a short-term sentiment reversal. That said, keep in mind that the clock is ticking on Energy Transfer’s unusually large dividend.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned BRK.B stock.