Energy Transfer (NYSE: ET) common units present a compelling long-term investment opportunity. This thesis is supported by:
- Consistent Free Cash Flow Generation: Energy Transfer generates outstanding free cash flow, crucial for maintaining financial health and supporting unitholder distributions.
- Value Creation for Unitholders: Management’s actions have significantly increased value for unitholders.
- Attractive Valuation: The units remain relatively inexpensive compared to peers.
Key Performance Metrics
To assess Energy Transfer’s performance, the following key metrics are essential:
- Free Cash Flow Yield
- Return on Invested Capital (ROIC)
- Enterprise Value-to-EBITDA (EV/EBITDA) Valuation
Free Cash Flow Yield
Free cash flow yield is calculated by dividing the trailing twelve months (TTM) free cash flow by market capitalization. This metric provides insight into the company’s ability to generate cash relative to its size.
Free Cash Flow Yield (TTM) – Energy Transfer and Peers
| Company | Market Cap ($B) | FCF ($B) | FCF Yield (%) |
|---|---|---|---|
| Energy Transfer | 51.8 | 6.91 | 13.3 |
| Enterprise Products | 61.3 | 4.42 | 7.2 |
| MPLX | 41.1 | 4.13 | 10.0 |
| Kinder Morgan | 43.3 | 3.92 | 9.1 |
| Plains All America | 11.7 | 1.74 | 14.9 |
Discussion: Energy Transfer and Plains All America lead in free cash flow yield, indicating a strong cash generation capability compared to peers. Energy Transfer’s consolidated financials include contributions from subsidiaries like Sunoco LP (SUN), USA Compression (USAC), and Dakota Access Pipeline (DAPL), which might inflate its operating cash flow and capital expenditures. Adjusting for these subsidiaries can provide a clearer picture, but even without adjustments, ET’s free cash flow yield remains robust.
Return on Invested Capital (ROIC)
ROIC is calculated using distributable cash flow (DCF) as it better represents the cash available to unitholders, accounting for non-cash and one-off expenses typical in the energy sector.
ROIC Calculation:
ROIC=Distributable Cash FlowTotal Assets−Current Liabilities−Cash\text{ROIC} = \frac{\text{Distributable Cash Flow}}{\text{Total Assets} – \text{Current Liabilities} – \text{Cash}}ROIC=Total Assets−Current Liabilities−CashDistributable Cash Flow
ROIC and WACC Comparison – Energy Transfer and Peers
| Company | ROIC (%) | WACC (%) |
|---|---|---|
| Energy Transfer | 8.5 | 6.3 |
| Enterprise Products | 13.0 | 6.7 |
| MPLX | 16.0 | 6.5 |
| Kinder Morgan | 7.2 | 6.9 |
| Plains All America | 9.1 | 6.5 |
Discussion: While Energy Transfer’s ROIC is lower than most peers, it still exceeds its WACC, indicating that the management is creating value. The trend shows improvement, with potential for a new high-water mark if 2024 EBITDA guidance is met.
Enterprise Value-to-EBITDA Valuation
The EV/EBITDA ratio is a critical metric for valuing energy transportation companies, combining equity and debt to provide a comprehensive capitalization measure and highlighting operational profitability.
EV/EBITDA (4-year average) – Energy Transfer and Peers
| Company | EV/EBITDA |
|---|---|
| Energy Transfer | 8.3x |
| Enterprise Products | 9.9x |
| MPLX | 9.9x |
| Kinder Morgan | 11.0x |
| Plains All America | 9.4x |
Discussion: Energy Transfer’s EV/EBITDA ratio is significantly lower than peers, reflecting a market discount possibly due to the company’s complex structure and historical perceptions of higher risk. However, this also means that ET units are currently undervalued.
Summary
Energy Transfer continues to be an attractive investment due to its strong free cash flow yield, positive ROIC relative to WACC, and undervalued EV/EBITDA ratio. The company’s ongoing improvements and management’s guidance for 2024 suggest further upside potential. My fair value estimate (FVE) for Energy Transfer units is approximately $20, considering a conservative 8.5x EV/EBITDA multiple and projected 2024 inputs.
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