In the stock market, it’s rare to find high-yielding stocks that make intriguing buys. This is because such stocks are often plagued by deteriorating fundamentals like a shrinking core business, mounting debt, or a high payout ratio. The market tends to price payout cuts into these businesses, creating a temporary mirage of high passive income until the payout cut materializes. Energy Transfer (ET), a major U.S. midstream energy company specializing in natural gas and crude oil transportation, storage, and export, looks to be the exception to this rule with its 7.6% distribution yield.
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After reviewing the midstream operator’s third-quarter earnings from last week, I am bullish on the company’s future. Without further ado, let me unpack the various reasons for my Buy rating.
Energy Transfer Posted Excellent Q3 Results
On November 6th, Energy Transfer shared strong third-quarter results for the period ended September 30th, which supports my bullish sentiment. The company’s total revenue edged 0.2% higher year-over-year to $20.8 billion during the quarter. Across the board, Energy Transfer delivered new partnership records to unitholders in the quarter: Crude oil transportation volumes surged 25%. Crude oil exports soared 49%. Midstream gathered and produced volumes grew by 6% and 26%, respectively. NGL fractionation volumes climbed 12%. Finally, NGL transportation volumes edged 4% higher.
Record volumes throughout its business led Energy Transfer’s adjusted EBITDA to rise by 11.8% over the year-ago period to just shy of $4 billion for the third quarter. Even accounting for the 8.6% uptick in the weighted average outstanding unit count, that’s respectable per unit growth for a midstream operator.
Energy Transfer Set for Strong Growth Ahead
Energy Transfer looks poised for solid growth in the coming years, which is another reason for my Buy rating. The partnership completed its acquisition of WTG Midstream Holdings in July for $2.275 billion in cash and 50.8 million newly issued common units. Through this deal, Energy Transfer picked up 6,000 miles of gas gathering pipelines to complement its existing network and extend its network into the Midland Basin. The partnership anticipates that a growing supply of NGL and natural gas volumes to its system will provide incremental revenue from gathering and processing activities. That’s expected to result in an extra $0.04 in distributable cash flow per unit in 2025, rising to $0.07 by 2027.
Additionally, Energy Transfer has a variety of projects that are currently under construction. That includes the Nederland Flexport Expansion project, which is expected to add 250,000 barrels a day of NGL export capacity at the Nederland Terminal. This is anticipated to be placed into service in the middle of next year. The Red Lake IV processing plant in the Permian Basin (200 million cubic feet per day of processing capacity) is expected to come into service in Q3 2025.
These are just a few of the reasons why beyond the projected 6.1% growth in operating cash flow per unit for this year, the analyst consensus remains promising in 2025 and beyond. For 2025, another 1.1% growth in OCF per unit to $3.25 is expected (as alluded to earlier, it will take time for the equity issuance for WTG to fully pay off). An additional 19% rise in OCF per unit to $3.86 is being predicted in 2026.
Energy Transfer’s Distribution Yield Can Keep Growing
Energy Transfer’s outsized distribution yield is another trait that I like about the stock. Its yield is approximately 6x more than the S&P 500 index’s (SPX) 1.2% yield. The company is also committed to upping its distribution by between 3% and 5% annually in the years ahead, too. This is being accomplished by $0.01 annualized increases in the distribution each quarter.
As Energy Transfer’s DCF per unit continues to move higher, I believe its annual distribution growth target is realistic. That’s because the company’s distribution was covered 1.8x by DCF in Q3 (~$2 billion in DCF versus $1.1 billion in distributions). After paying its distribution, Energy Transfer had all but $198 million to fund both its growth capex (dedicated to new construction and expansion projects) and maintenance capex (dedicated to maintaining existing infrastructure).
The partnership also enjoys a BBB credit rating from S&P Global (SPGI) on a stable outlook. This is because, adjusting for a full year of acquisitions, Energy Transfer expects its leverage ratio to be in the lower half of its 4.0-4.5x targeted range in 2024. That’s exactly where credit rating agencies like to see a midstream operator. In other words, as Energy Transfer’s adjusted EBITDA keeps climbing, its debt load can increase in absolute numbers while the leverage ratio remains in an ideal range.
ET’s Valuation Supports Bullish Outlook
Energy Transfer’s valuation is another factor that, from my perspective, bullishly positions it. The company’s forward price-to-OCF ratio of 5.3 is below its 20-year average P/OCF ratio of 6.3. Given that Energy Transfer’s growth profile appears to be holding up, I believe a reversion to the 20-year average could be around the corner. This paves a viable path to a $20 unit price in the near term, which I argue would be compelling.
Is ET Stock a Buy, According to Analysts?
Turning to Wall Street, analysts have a Strong Buy rating consensus on Energy Transfer. All eight analysts covering the stock have assigned Buy ratings in the last three months. The average 12-month ET price target of $20.29 implies Energy Transfer could gain 18.83% from the current unit price.
Conclusion
Energy Transfer is a pick that I think offers the best of both worlds: Massive starting income and the potential for significant capital appreciation. The distribution is backed up by a business with loads of cash flow. The company’s backlog of projects also sets it up to keep growing the cash flow. For these reasons, I am assigning a Buy rating to Energy Transfer.
