Energy Transfer: Top Pick for Income

08/26/2015 8:00 am EST

Focus: STOCKS

Ari Charney

Analyst and Associate Editor, Canadian Edge and Personal Finance

This has been a challenging year for income investors. But even as we endure sharp corrections in some of our favorite sectors, it’s important not to lose sight of our long-term goals, asserts Ari Charney, editor of Utility Forecaster.

For those with new money to invest, the recent sell-offs in utilities and master limited partnerships (MLPs) offer an opportunity to start building positions while locking in higher yields than were available just a year ago.

Energy Transfer Partners LP (ETP ) has suffered one of the more alarming slides among our MLPs.

Despite the challenging operating environment, ETP managed to perform far better than expected during what’s typically a seasonally weak quarter.

Indeed, the company beat analyst estimates for revenue and EBITDA (earnings before interest, taxation, depreciation and amortization) by 16.8% and 8.9%, respectively.

Even so, revenue declined 11% from a year ago, to $11.5 billion, though adjusted EBITDA climbed 6.8%, to $1.5 billion.

Distributable cash flow (DCF) per unit, the primary profit metric for an MLP, fell 30.9% from a year ago, to $1.23.

However, that was still good enough to cover the payout by 1.03x, though coverage in the prior-year quarter was a much more comfortable 1.53x.

A big part of the drop in DCF on a per-unit basis is attributable to the deal-making spree—both internally and externally—undertaken by CEO Kelcy Warren, who’s a bit of a cowboy on the mergers and acquisitions front.

The number of units outstanding is up nearly 57% from a year ago.

If ever there was a time for deals, it’s in this depressed operating environment, so long as a firm still has access to capital and sufficient growth to support a rising debt burden.

On that score, J.P. Morgan believes that with “an embarrassment of project riches”—the backlog of high-quality projects stands at around $10 billion—ETP will have a limited need for further secondary equity issuances.

ETP still enjoys strongly bullish sentiment among Wall Street analysts, at 11 buys and four holds. The consensus 12-month target price is $64.25, which suggests potential appreciation of 29% above the current unit price.

After holding its payout level through both the Great Recession and much of the ensuing recovery, ETP has bumped its payout for eight consecutive quarters. The latest quarterly payout, at $1.035 per unit, has grown nearly 16% over the past two years.

With a forward yield of 8.3%, ETP is one of our top picks for long-term growth and income in the Income Portfolio and a buy below $70.

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