Strategic Expansion Leads to Impressive Growth for Energy Transfer Equity
Note to Investors: My recommendation is based upon an investment thesis to last 2-5 years. I expect Energy Transfer Equity LP’s annual distribution to grow by 20% for the next 2-years. The partnership has plenty of catalysts to expand free-cash-flow (FCF) and the distribution.
The units are expected to split 2:1 effective on January 27, 2014.
Founded in 2002, Energy Transfer Equity LP (ETE) is a well diversified energy master limited partnership (MLP) which through its two publicly-traded subsidiaries – Regency Energy Partners LP (RGP) and Energy Transfer Partners LP (ETP) – sells gathers, processes, transports and stores natural gas and crude, and serves a diverse group of clients including electric utilities, industrial users, local distributors and power plants.
Regency focuses on gathering, processing, compression and treating. Energy Transfer Partners focuses on transportation, storage and distribution through Sunoco Inc. for retail marketing and Sunoco Logistics Partners LP (SXL) for pipeline transportation, terminal storage and crude oil acquisition and marketing. Energy Transfer Equity holds limited partner, general partner and IDR (incentive distribution rights) interests in Regency and Energy Transfer Partners.
Through its subsidiaries, Energy Transfer Equity owns roughly 7,800 miles of natural gas transportation pipelines, three natural gas storage facilities and 12,700 miles of interstate natural gas pipelines. In addition, Energy Transfer Equity’s midstream business segment owns 6,700 miles of in-service natural gas and NGL (natural gas liquids) gathering pipelines, four natural gas processing plants, 15 natural gas treating facilities and three natural gas conditioning facilities. The company also owns 300 miles of NGL pipelines, a 50% interest in the 85-mile Liberty NGL pipeline and a 70% interest in a Lone Star joint venture that owns NGL pipelines (2,000 miles), three processing plants, NGL storage facilities (47 million barrel capacity) and two fractionation plants.
Energy Transfer Equity subsidiaries operate convenience stores in 25 U.S. states and sell gasoline, middle distillates, crude oil and refined products, and provide treating, conditioning cooling, compression and dehydration services to other midstream pipeline operators and natural gas producers. The company’s activities are primarily focused on the East and Southwest regions of the U.S., as the map below shows.
Management has strongly focused on revenue diversification and risk mitigation. The company owns the largest intrastate pipeline system in Texas; has diversified, stable, long-term, low-risk fee-based cash flows; established an NGL platform with expanded downstream NGL capabilities (through the LDH Energy acquisition) to serve producer demand; minimized exposure to weather sensitive non-core business; expanded geographic reach with the Southern Union merger, with stable fee-based income; created best-in-class natural gas, crude oil, NGL and refined product logistics and transportation platform with Sunoco acquisition; and diversified into higher-margin rich gas and liquids business in Eagle Ford and with the NGL build out.
During the recession of 2008, Energy Transfer Equity units had dropped as low as $16.18. Since then, units have appreciated approximately 425% as management used strategic acquisitions, partnerships and expansion techniques to turn the company around. Energy Transfer Equity’s units were trading at $84.83 as of 1/23/2014, with a market capitalization of $23.8 billion and a price-to-earnings ratio of 57.41.
For its third quarter ended 9/30/2013, ETE made a cash distribution of $0.6725 per unit, $2.69 annualized, on November, 19, 2013, for a distribution yield of 3.20%. This marks ETE’s eighth consecutive year of dividends, which have steadily increased from $0.80 annualized in 2006. ETE has also delivered total annualized returns of 17.8% since 2007 (including dividends), well above the 5% return of the S&P 500. Earnings are expected to grow at 15% going forward. However, units have risen significantly and could see near-term correction.
Energy Transfer Equity and its subsidiaries generate revenue primarily by charging fees – for inter- and intra-state transportation and storage of natural gas, NGLs and crude; for gathering, transporting, storing and processing oil and gas products, and from retail sales of gasoline, diesel and convenience merchandise. Fees are usually agreed upon under various contract terms (keep-whole, percent-of-proceeds and acreage dedication). As the table below shows, a substantial proportion of the company’s transportation, storage and midstream revenue is from long-term fee-based contracts with good visibility.
ETP Subsidiary – Growth Drivers
Growth at Energy Transfer subsidiary, Energy Transfer Partners (ETP) will be driven by in-service plants, seven under development projects (such as West Texas Cryo, the Mexico Export project, trunk line crude conversion, the Lake Charles LNG facility and LNG supply opportunities). In addition, ETP is currently evaluating five additional projects such as midstream and retail market acquisitions, gas processing opportunities, adding fractionation capacity, and natural gas and LPG export opportunities.
ETP is also positioning itself for significant growth in Eagle Shale with advance gathering footprint, system integration, advance processing and takeaway capacity and extending the vertical value chain, with investments of over $3.1 billion in pipelines, HP compression, natural gas and NGL processing capacity and fractionation capacity.
These improvements and expansions have increased Eagle Ford’s processing capacity by 175%, moving Energy Transfer Partners from the 5th largest midstream company in 2010 to the 2nd largest midstream company with processing capacity of 1,340 mbpd, up significantly from 120 mbpd in 2010.
NGL Growth Drivers
Over the past few years, ETE has acquired and significantly expanded its NGL related assets. Going forward, the company plans to grow its NGLs business through the optimization and expansion of existing assets across the NGL value chain through transport, distribution, fractionation, storage, marketing and trading.
Energy Transfer plans to significantly expand its NGL liquid volumes across all stages of the supply chain (see Liquid Volume Growth table below) through 2015.
Retail Market Growth Opportunity
Through Sunoco, Energy Transfer has a highly visible retail branded presence with #1 market share in Pennsylvania and New York, and #3 market share in New Jersey. Moreover, the fragmented nature of the business offers significant acquisition and consolidation opportunities. Sunoco gives the company a platform for growth in a fragmented industry, with expanded buying power and geographic synergies, while leveraging the Sunoco brand and capitalizing on management expertise to operate other brands and deliver back office synergies.
Industry and Competition
The natural gas and oil transportation, storage and processing industry is fairly sensitive to demand, supply and regional and global economic, weather and other influences. As a whole, the industry suffered a tremendous slowdown during the recession of 2008. Also, since taking office, President Obama has sizably reduced federal subsidies for the oil and gas industry in the face of record profits reported by major public E&P companies.
Like its peers, Energy Transfer Equity was impacted by the recession but has bounced back better than its top competitors. The line-graph below shows the ETP subsidiary’s relative price performance compared to Kinder Morgan Energy Partners LP (KMP), Enterprise Products Partners LP (EPD) and Plains All American Pipeline LP (PAA), and shows a steady upward march in relative price performance.
Over the last twelve months, the ETP subsidiary has had better relative unit price performance than its competitors. Only Enterprise Products Partners had comparable performance. Plains All American Pipeline had a strong initial performance but its stock price significantly dipped in the second half of 2013. Over the past three years, the Energy Transfer Partners subsidiary had unit yield between 7% and 9%, most recently coming in slightly below 7%. None of its competitors have been able to crack the 7% yield mark, although Kinder Morgan Energy Partners came close at the end of 2013.
Energy Transfer Equity has the third largest market capitalization of the group but leads in revenue. The company reported total revenue of $47 billion while Kinder Morgan Energy Partners reported $12.5 billion, Enterprise Products Partners reported $45.7 billion and Plains All American Pipeline reported $41.06 billion. Energy Transfer Equity also boasts quarterly earnings growth of 328.6%, well above its competition. However, the company needs to improve operating margins to stay competitive over the long run.
In December 2013, Energy Transfer Equity closed a tender offer on 7.5% Senior Notes, due 2020. The company received 34% ($613 million) of the senior notes, bringing the remaining balance to $1.187 billion. The tender offer was funded by a public offering of $450 million in 5.875% Senior Notes due 2024 and portions of a newly restructured $1 billion term loan credit facility and a $600 million revolving credit facility. Management expects this debt refinancing to reduce annual interest by $16 million and increase distributed cash per unit by $0.06, annualized.
Sale of New England Gas Assets
New England Gas is a division of Southern Union Company which is a wholly owned subsidiary of Energy Transfer Equity. The company sold New England Gas assets to Liberty Utilities Corporation in December 2013 for $40 million in cash and $20 million in debt. Management hopes the selling of these assets will streamline and simplify business operations, and add to unit holder value.
Strong Revenue Growth and Diversification Since 2012
Energy Transfer saw strong growth and diversification in its business capabilities in 2013, with increased revenues and cash flow. For the nine months ended September 30, 2013, the company had adjusted EBITDA of $2.97 billion, an increase of 65% from the same period in 2012.
The bar chart below breaks down adjusted EBITDA by operating segment for full year since 2009 and the last twelve months ended September 30, 2013 for the Energy Transfer Partners subsidiary. Over the past five years, Energy Transfer has diversified its portfolio by introducing new revenue streams. Interstate pipelines have also become the largest income source, overtaking intrastate pipelines in 2012. Crude oil and refined products are now the second largest source of income, up 304% since 2012.
Energy Transfer Equity’s structure aligns its interest in maintaining and increasing LP distributions at its subsidiaries over time, and this should increase cash flow to ETE.
Board of Directors Plan for a Strong 2014
At the close of 2013, the Board of Directors for Energy Transfer Equity approved a four step plan to promote long-term growth. The first part of the plan is a 2-for-1 stock split for unit holders on record as of January 13, 2014. Next, Energy Transfer Equity will initiate a $1 billion common unit buyback program that can be used any time management deems appropriate. All common units will be purchased in the open market. In addition, the company will purchase approximately $400 million of Regency Energy Partners LP (RGP) common units (16.5 million common units) as consideration for Regency Partners’ acquisition of midstream business from Eagle Rock Energy Partners. Lastly, Energy Transfer Partners expects to receive approval (from the Federal Energy Regulatory Commission) for its Lake Charles LNG export project and start construction in 2015, with exports expected to commence in 2019.
Energy Transfer Equity is expected to seek additional midstream and retail market acquisitions, and analyze opportunities in natural gas processing, and natural gas and LPG exports.
John McReynolds serves as President of Energy Transfer Equity and a Director of Energy Transfer Partners. McReynolds has held these positions since 2005. Before joining the company, he practiced law focused on the energy industry. Jamie Welch serves as Group CFO and Head of Business Development. He has previously held senior financial positions with Credit Suisse and Lehman Brothers, and brings over 30 years of experience to the company.
Kelcy L. Warren serves as CEO of Energy Transfer Partners and Chairman of the Board of Directors for Energy Transfer Equity. Mr. Warren has over 25 years of energy industry experience and was a cofounder of the entities that owned midstream assets that were eventually acquired by Energy Transfer Partners. Marshall McCrea originally joined Energy Transfer Partners in 1997 and has been COO and President of the company for the last six years. CFO Martin Salinas Jr joined Energy Transfer Partners in 2004 and brings over 20 years of financial experience in the energy industry to the company.
Management plans to continue operating the company with fiscal responsibility and a unitholder orientation focused on cash flow, distribution growth, investment grade credit and liquidity.
Energy Transfer Equity saw consolidated revenue of $12.5 billion for the quarter ended September 30, 2013, up sizably from the prior year quarter on acquisitions on across the board gains and jumps tied to crude and refined product sales. Limited Partners’ Net income increased substantially to $150 million with diluted net income of $0.52 per unit, up from $0.23 per unit in 3Q12.
As of September 30, 2013, the company held cash and cash equivalents of $1.177 billion, up from $372 million. Total assets stood at $50 billion. With management redeeming higher interest debt, long-term debt increased to $22 billion. Total equity was up marginally to $17.2 billion.
Operating activities generated net cash of $1.85 billion for the nine months ended September 30, 2013, up from $897 million in the same period of 2012. The company used $833 million on investing activities, primarily for capital expenditures. Proceeds from subsidiaries and asset sales partly financed investments in 2013. Financing activities used $209 million, net of debt and equity proceeds and distributions.
Energy Transfer Equity has done a solid job of bouncing back from the recession in 2008, and positioning itself as a leading energy MLP. Management has been making the right decisions on acquisitions, partnerships and organic expansion, while divesting non-strategic assets. Energy Transfer Equity is clearly well positioned for continued future growth with high visibility from fee-based contracts and expanding domestic and global demand for oil, natural gas and NGLs. Unitholders should continue to see a steady increase in distributions. Units appear to have run up significantly over the past year and could come in for some correction. Even so, at current levels, units offer an attractive 3.2% yield that is only likely to grow over time.