Why Income Investors Should Put Energy Transfer Equity LP on Their Watchlists

Midstream giant Energy Transfer Equity (NYSE: ETE) has been excruciatingly volatile over the past few years. At one point, units of the master limited partnership (MLP) lost more than 80% of their value, and they are currently about 50% below their peak. While the volatility has moderated somewhat this year — with units flat overall — they've still been all over the map, up almost 10% at one point before plunging double-digits and then recovering.

Despite all of the movement, Energy Transfer Equity appears to be heading in the right direction, which makes it an interesting stock for income investors to put on their watchlists given that it pays a generous 7.1%-yielding distribution.

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The numbers are noticeably better

One of the factors driving all of this volatility is Energy Transfer Equity's financial metrics, which had been in rough shape because of the oil market downturn. For example, in the first quarter of 2017, the company only generated $215 million of distributable cash flow (DCF), which wasn't enough to cover the $251 million in cash it distributed to investors. However, thanks to the wind-down of some special assistance to its namesake MLP Energy Transfer Partners (NYSE: ETP), Energy Transfer Equity's DCF rocketed 84% to $395 million during the first quarter of 2018. With the company only distributing $266 million in cash to investors, it was able to cover its high-yielding payout by a comfortable 1.48 times.

Meanwhile, cash flow should continue growing in the coming year because Energy Transfer Partners expects to complete several expansion projects, which will boost the cash it sends to its parent. In addition to that, Energy Transfer Equity recently acquired a stake in USA Compression Partners (NYSE: USAC) as part of a transaction with Energy Transfer Partners, which will provide it with some incremental cash flow going forward.

While Energy Transfer Equity could use its expanding cash flow to boost its high-yielding distribution, the company currently plans to retain this excess money to help pay down some debt, which should improve its balance sheet. That will assist the company with meeting its top priority to deleverage its balance sheet so the franchise can maintain an investment-grade credit rating, which will keep its borrowing costs low, giving it the financial flexibility to continue growing.

A catalyst on the horizon


Another reason Energy Transfer Equity wants to shore up its balance sheet is so the company can pursue the acquisition of Energy Transfer Partners to simplify its corporate structure. CEO Kelcy Warren stated last quarter that they've "looked at every scenario possible to us. And we don't see any mathematical scenario that makes any sense other than" having Energy Transfer Equity acquire Energy Transfer Partners.

That deal would mark the latest in a string of similar consolidation transactions in the midstream sector as companies seek ways to enhance their appeal to investors by simplifying their structures and improving their financial profiles. In Energy Transfer Equity's case, it could maintain its current distribution level after acquiring its MLP, and use its growing stream of excess cash to deleverage further and internally fund some expansion projects, which would improve the company's long-term financial sustainability. Meanwhile, once it gets its finances on solid ground, Energy Transfer can look at resuming distribution growth.

Things are getting interesting

After struggling for the past few years, Energy Transfer Equity's financials are heading in the right direction, which positions the company to grow its high-yielding payout in the future. However, it still has more work to do, including sealing a deal to buy Energy Transfer Partners, which is why investors might want to put it on their watchlists for now to see how everything shakes out.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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