This year has been both the best of times and the worst of times for pipeline behemoth Energy Transfer (NYSE: ET). On the one hand, the energy company is on track to generate record earnings, with its adjusted EBITDA on pace to come in between $11 billion and $11.1 billion, up about 16% from 2018’s total. The MLP‘s unit price, however, has fallen about 14% this year.
Because of that, the company now sells for an insanely cheap price. That makes it a great stock for value investors to consider buying this December.
Drilling down into the valuation
The slump in Energy Transfer’s unit price has pushed its enterprise value (EV) down to around $88 billion. With the MLP on track to generate roughly $11 billion in EBITDA, it trades at about eight times its EV/EBITDA, which is a common valuation metric for energy companies. That’s ridiculously cheap, even in the beaten-down energy midstream sector.
It’s by far the lowest valuation among the large diversified U.S. pipeline companies. On average, the group currently sells for around 11 times their EV/EBITDA. Meanwhile, midstream assets are fetching about 13 times EBITDA on the M&A market.
Why so cheap?
One factor that seems to be weighing on Energy Transfer’s valuation is its debt. Its leverage ratio is currently a bit above its 4.0 to 4.5 times debt-to-EBITDA target. However, that number should slide into that range next year, with the company on track for a 4.2 times leverage ratio given its current earnings growth projection. While that’s higher than some of its peers — several of which have leverage metrics below 3.5 times — it would be a big improvement for Energy Transfer, given that its leverage ratio was above 5.7 times at the end of 2016.
Another factor that seems to be weighing on Energy Transfer’s valuation is its recent decision to acquire SemGroup (NYSE: SEMG) for $5 billion. Energy Transfer’s unit price has slumped about 15% since it made that announcement, due in part to the 65% premium it’s paying for SemGroup. That price, however, isn’t as high as it might seem, since Energy Transfer is paying only about nine times EBITDA for SemGroup after factoring in the expected cost savings. Because of that, the transaction will boost Energy Transfer’s cash flow on a per-unit basis. Further, that deal is highly strategic since it will provide Energy Transfer with another large-scale oil export terminal along the U.S. Gulf Coast. It will also enhance the company’s growth prospects by facilitating the development of the Ted Collins Pipeline, which will link those two Gulf Coast export terminals.
More growth ahead
The SemGroup deal alone should boost Energy Transfer’s EBITDA by about 5% next year. Meanwhile, the company will continue benefiting from its expansion-related investments, with it spending $8 billion in the 2019 to 2020 time frame on organic growth. It finished four projects over the past few months and has several more starting up in 2020. While Energy Transfer hasn’t yet put out its 2020 outlook, these dual fuels should drive another double-digit increase in its EBITDA next year, with further growth in 2021 as the Ted Collins Pipeline comes online.
Too cheap to ignore
Energy Transfer trades at the lowest valuation in its peer group by a wide margin. That discount doesn’t make much sense given that the company’s earnings are at a record level, its balance sheet is improving, and it recently made a sensible acquisition. Because of that, it’s a stock that value investors won’t want to miss, especially since they’ll get paid well while they wait for the company’s valuation to improve. That’s because Energy Transfer currently pays a 10.7%-yielding dividend, which it can comfortably cover with cash flow with lots of room to spare. Add that payout to its growth prospects and valuation upside and Energy Transfer could produce substantial total returns for value investors.
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