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Could Buying Energy Transfer Stock Today Set You Up For Life?
Energy Transfer (NYSE: ET) has a very attractive yield at 6.9%. That will draw the eyes of most income investors today, noting that the S&P 500 index has a miserly yield of just 1.2% or so. Even the average energy stock's yield is far lower, at around 3.1%.
Before you buy Energy Transfer thinking that it will set you up with a lifetime of income, though, you'll want to consider some facts about the past.
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Energy Transfer's business looks attractive
Energy Transfer is what is known as a midstream company. It owns energy infrastructure like pipelines, storage facilities, transportation equipment, and processing assets that are vital to the day-to-day functioning of the overall energy industry.
However, unlike the upstream (oil and gas production) sector and the downstream (chemicals and refining) sector, midstream assets aren't usually affected by commodity prices. Customers generally pay fees for the use of the vital infrastructure assets that businesses like Energy Transfer own.
Image source: Getty Images.
A fairly reliable stream of fee income is what underpins the distributions paid by midstream players like Energy Transfer. In this regard, it makes sense that income-focused investors would be attracted to this master limited partnership (MLP).
Adding to the allure is the fact that the company has an investment-grade balance sheet, and that its distributable cash flow covered the third quarter distribution by a strong 1.8 times.
It's also fairly diversified. It breaks its business down roughly equally across four different midstream subsectors and a division dedicated to its ownership stakes in other midstream businesses.
In some ways, it looks like a one-stop shop in the midstream niche. But don't buy it just yet; there's some history here you need to consider.
What happens when the energy sector is struggling?
From a distance, it seems like Energy Transfer should be able to use its fee-driven business to easily steer through an energy industry downturn. Only that isn't what happened in 2020, when the pandemic led to a steep decline in energy prices.
During that industry weak patch, the MLP actually ended up cutting its distribution in half. To be fair, there was a huge amount of uncertainty in the world at the time, so this move was likely a precautionary measure that made a lot of sense given the circumstances. And the distribution is now higher than it was prior to the cut.
However, right when income investors would be looking to Energy Transfer for income security, it let them down. Other midstream competitors managed to maintain or even increase their dividends.
The company didn't distinguish itself during the previous energy downturn, either. In 2016, the MLP ended up trying to get out of an acquisition it had initiated. Completing the purchase, according to management, would have left Energy Transfer with a debilitating debt pile and may have forced it to cut its dividend.
It made sense to try to scuttle the deal. But the effort to do that included the sale of convertible securities, a large portion of which went to the then-CEO (who is now the president of the board of directors).
The convertible securities would have effectively protected the CEO from a dividend cut if the deal had gone through. Again, right when investors would have been looking to be front and center with management, they weren't.
Energy Transfer may not be the best option
The problem with the MLP isn't as much about the business as it is about trust. It has a high yield that seems well supported. That distribution has been growing over time.
But what can an investor expect when the chips are down? If that question worries you, as it probably should, given Energy Transfer's history, you might want to look elsewhere. Competitors like Enterprise Products Partners (NYSE: EPD) and Enbridge (NYSE: ENB) have much better track records of putting income-focused investors first.
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Reuben Gregg Brewer has positions in Enbridge. The Motley Fool has positions in and recommends Enbridge. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
