When I last wrote about Energy Transfer (NYSE:ET) stock, I was optimistic shares of the midstream energy player would continue to erase losses. Well, I was right and wrong. ET stock is up 42% since hitting a low of $4.56 per share back on March 18. But in the last month, the stock has fallen over 18%, and the reasons are understandable. Its balance sheet is highly leveraged, and regulatory issues are taking their toll.
Meanwhile, oil production companies are still looking for prices to return to pre-pandemic levels. Several companies have shored up their balance sheets, but that financial strength will evaporate if demand does not bounce back quickly.
Most analysts agree that it will take time for oil demand to recover. In a research note, Goldman Sachs (NYSE:GS) said we should not expect a full recovery until 2022. Meanwhile, Citigroup (NYSE:C) believes demand for refined oil products will never return to the levels seen before the novel coronavirus pandemic.
It does not matter which camp you are in at this point. The bottom line is that it will take a while before you see things get back to normal.
For these reasons, it seems that it will take longer than expected for Energy Transfer stock to return to greener pastures. That’s why investors may want to wait on the sidelines before pouring capital into this one.
Dakota Access Pipeline Fight Highlights Regulatory Risks
Perhaps the most significant piece of news concerning Energy Transfer stock at the moment is the closure of the Dakota Access pipeline. Although it constitutes a small portion of the overall pie for the company, it still highlights the regulatory risks pipeline operators face.
A bright spot over here is that the U.S. Court of Appeals for the District of Columbia said the company could continue to pump crude oil from the site as the legal battle wages for its future. That will come as a relief for the energy company as it stands to lose $3.5 million every day that the site remains idle and approximately $1.4 billion if the pipeline remains unused in 2021.
Debt Is Weighing Down ET Stock
One of the main reasons why markets reacted severely to the Dakota Access pipeline litigation is Energy Transfer’s debt profile. Coming into this crisis, the company was highly leveraged as is. But Covid-19 exacerbated the situation, pushing the debt-to-EBITDA ratio to 24.02 times, a substantial uptick sequentially from 4.78 times in the fourth quarter of 2019.
In my last piece, I had mentioned how I was surprised that the company was still spending a healthy amount on capital expenditures when most of the industry had dialed itself back on that front. Considering the run of play, it looks like ET has bitten off more than it can chew.
For the first time in a while, there is a real danger it will have to cut its dividend to free up capital. That may not be something that investors enjoy. But it’s a necessary step to maintain its investment-grade credit rating.
The bottom line, a leveraged balance sheet leaves it susceptible to prolonged slowdown and regulatory risks. It would be best to deleverage to sustain its operations for the foreseeable future.
Domino Effect
Chesapeake Energy (OTCPK:CHKAQ) filed for bankruptcy last month. The company has requested the bankruptcy court to release it from its contractual obligations with Energy Transfer. Although it is an alarming development, it’s not surprising.
Oil production companies are suffering due to Covid-19. Revenues are taking a hit, and companies are faced with two options; either they decide to scale down operations or they can choose to close shop. As I wrote in my last piece on the company, there were a host of reasons why Chesapeake found itself wanting, when Covid-19 decimated its operations. However, no one can deny that the virus served as the final nail in the coffin for Chesapeake.
For a company as large as Energy Transfer, the bankruptcy will not impact earnings much. However, it could have a domino effect, leading to more suppliers canceling or rescheduling contracts as bankruptcies ramp up in the industry, and revenues remain stressed.
Final Word on ET Stock
In my last piece, I argued that Energy Transfer had the legs to survive the selloff. However, several key developments since that time lead me to believe management needs to make some hard choices before gains are realized. Regulation has become a hot-button issue for the company in recent months. The forthcoming 2020 presidential election will also have a crucial role to play in that regard.
Due to its significant debt holdings, Energy Transfer remains at considerable risk to regulation and a prolonged slowdown. Management needs to rethink its aggressive expansion strategy, considering recent events. An environmental review on its pipelines will also help.
A course correction will yield an increase in share prices. In the meantime, it’s best to avoid Energy Transfer stock at the moment.
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.
