With interest rates likely headed lower over the next few years as the Fed embarks on a rate-cutting cycle, income-oriented investors may be looking for places to invest that can offer higher yields and attractive returns. One such option is an investment in pipeline operator Energy Transfer (NYSE: ET).
The company owns one of the largest integrated midstream systems in the U.S., where it transports hydrocarbons (natural gas, natural gas liquids, and crude) and performs other services across the midstream value chain, such as storage, gathering, processing, and fractionation, among others.
Let's look at three reasons to buy Energy Transfer stock like there is no tomorrow.
A high yield and increasing distribution
One of the first things that inevitably draws investors to Energy Transfer is the stock's juicy 7.8% forward yield. The master limited partnership (MLP) currently pays out a $0.32 quarterly distribution, which it plans to grow by between 3% and 5% a year moving forward.
Note that as an MLP, Energy Transfer pays a distribution, not a dividend. While similar, distributions include a return on capital that is untaxed until the units are typically sold, making them tax-deferred. However, investors do receive what is called a K-1 and must fill out some extra tax forms.
While Energy Transfer cut its distribution in half in 2020 to help repair its balance sheet, the distribution is higher today than before the cut. The company's balance sheet is currently in good shape, with leverage (as used by rating agencies) toward the low end of its 4.0x to 4.5x target range.
At the same time, Energy Transfer's distribution is well covered, as reflected in its over 1.8 times distribution coverage ratio in the second quarter. This is based on its non-consolidated distributable cash flow, which is its cash flow before growth capital expenditures (capex). Energy Transfer has partial stakes in a few companies, so the non-consolidated number is the cash flow it gets to keep.
Overall, Energy Transfer has a high, well-covered yield with a distribution that should continue to grow.
Growth opportunities
In addition to its nice yield, Energy Transfer has solid growth opportunities in front of it. The company has one of the midstream sector's largest backlogs, with several projects set to go into service next year and the year after.
It plans to spend around $3.1 billion on growth projects this year. The company typically looks for at least a 12% return on its spending, which would help boost earnings before interest, taxes, depreciation, and amortization (EBITDA) by more than $370 million per year once all the projects are fully ramped up.
Energy Transfer is also well positioned to deliver natural gas to help supply the increasing energy needs of artificial intelligence (AI)-focused data centers. AI data centers use an enormous amount of energy, and these companies need reliable, cheap, and uninterruptible energy. Nuclear energy and natural gas are the best ways to provide this.
While cloud computing companies are starting to turn to nuclear energy, most of these projects are at least several years away. Meanwhile, Energy Transfer has been signing deals with power companies to supply more natural gas based on increasing AI demand and has had discussions with cloud computing companies looking to build onsite power generation.
Taken altogether, Energy Transfer has solid growth opportunties in front of it over the next several years.
Inexpensive stock
Despite Energy Transfer's valuable midstream system, growth opportunities, and solid financial footing, its stock trades at one of the lowest valuations in the MLP midstream space.
Typically, investors value midstream companies using an enterprise-value-to-EBITDA (EV/EBITDA) multiple. The reason for this is twofold. The first is that enterprise value takes into consideration the amount of net debt a company carries on its balance sheet. These are capital-intensive businesses, so operators in the space typically carry debt to help fund their projects.
EBITDA, meanwhile, excludes non-cash depreciation expenses that would otherwise be included with earnings. Midstream companies spend money upfront on projects through capex, and those expenses are then depreciated over the useful life of the asset. By using EV/EBITDA, the costs of the projects are captured in its debt net, while EBITDA is more reflective of the company's current operating profitability.
Based on this metric, Energy Transfer trades at an EV/EBITDA of 8.1 times based on 2025 estimates, well below its historical levels and one of the lowest valuations in the MLP space.
The midstream MLP sector as a whole, meanwhile, trades at a pretty large discount to where it did several years ago, with the industry trading at a 13.7 times average EV/EBITDA multiple between 2011 and 2016. With the industry as a whole in better financial shape than during this period, the sector could re-rate higher in the coming years if the midstream companies can show themselves to be AI energy winners.
Overall, given Energy Transfer's current valuation and growth prospects, together with an attractive yield and growing distribution, the stock looks like a buy.
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Geoffrey Seiler has positions in Energy Transfer, Enterprise Products Partners, and Western Midstream Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
3 Reasons to Buy Energy Transfer Stock Like There's No Tomorrow was originally published by The Motley Fool