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Income, Stocks  | June 18, 2020

Energy Transfer (NYSE:ET) shares have recovered somewhat in the last month, but are still down about 16% year-to-date. As is the case with most energy stocks, investors balked at the sight of any oil and gas company due to the novel coronavirus. That led to a substantial dip in ET stock prices. However, energy stocks have since rebounded.

If you hold ET stock, there are several other reasons to be happy. And these reasons have nothing to do with general market enthusiasm.

Cash flows are increasing at an impressive rate, and liquidity metrics are holding steady. The company is also heading to a cash flow positive situation by 2021. In light of the Covid-19 situation, Energy Transfer has also cut its capital expenditure budget. However, it’s not like the company has put the breaks on its expansion strategies – it will still spend $2 billion annually on increasing capacity.

In short, the company has laid out a robust plan for its growth and profitability. I expect the markets will take note of this and reward ET stock accordingly.

What S&P’s Negative Outlook Means

On May 12, credit rating agency S&P Global affirmed the company’s BBB- rating but changed its outlook to negative from stable. S&P anticipates leverage to be approximately 5.5 times in 2020 and fall to 5.0 times in 2021. Long-term debt-to-EBITDA stands at 5.0 times at the moment, so the rating agency’s concerns are not unfounded. However, I believe that there is no reason why investors should anticipate a downgrade coming anytime soon.

The company recently completed an offering of $4.5 billion of senior notes and $1.6 billion of preferred units. It used the proceeds to pay the debt due this year and for general purposes. The debt extinguished carried higher coupon rates than the fresh notes, and the preferred stock save shareholders from dilution of ownership. All of these are right moves in my book, but it’s clear that the rating agencies are looking for something more.

There is a real fear that pressure on crude oil prices will eat away at EBITDA for midstream companies. If that happens, the pressure will mount to increase debt, putting strains on covenants. Rating actions will soon follow and the domino effect can be quite devastating.

However, long-term debt has decreased year on year, and the new capital raising moves are savvy. The rating agency’s note is more of a nudge for Energy Transfer and not a final warning. Management can look at it as a benchmark to aspire toward and then pace itself accordingly.

Slashing of the Capex Budget

In response to Covid-19, several companies slashed their capex budgets to the bone. I’m not surprised that ET made cuts as well, but what’s interesting is that they were not as substantial as some other instances we’ve seen in the industry.

The company has cut its spending for the year to approximately $3.6 billion, and a majority of that amount has already been spent. Management is mulling paring down its budgets further to shore up its balance sheet. I feel that it’s an either-or situation at this point.

Several companies in the industry are in survival mode and aren’t spending a buck on increasing capacity. I am happy that Energy Transfer is not going down this route, and instead, it’s focusing on a plan to spend roughly $2 billion prospectively to increase capacity and scale. That will drive profitability and liquidity as we tread further along the road to recovery.

Insider Purchases Show Management’s Confidence

Company insiders hold a lot of ET stock, underlining their confidence in the company. CEO Kelcy Warren alone owns $288 million of shares, while former CEO and current director Ray Davis owns another $180 million. Despite the Covid-19 situation and the uncertainty surrounding crude oil prices, insiders still purchased 247,000‬ shares, showing you that they do believe in the bright future of the company.

And why shouldn’t they be? The company is moving in the right direction. Any investor worth his or her salt would love to get their hands on a stock that has the legs to run and is trading at a discount.

Final Word on ET Stock

Energy Transfer has a lot going for it, so I think the stock will continue to erode its losses moving forward. The company is moving toward a positive cash flow position and doesn’t suffer any liquidity issues that could affect its dividend.

At the same time, the company will continue to invest in its operations when most big-ticket industry players have decided to slash capex budgets. That will put it in the box seat once the dust settles on the Covid-19 situation.

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