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Summary
- Because of this restrictive environment that inhibits competition, Energy Transfer Partners is in an enviable position with decades of growth ahead secured by growing demand for American hydrocarbons.
- This is an opportunity to own essential infrastructure that facilitates global energy security and American leadership in the global transition from dirty hydrocarbons (like coal) to cleaner hydrocarbons (like natural gas).
- We believe Energy Transfer’s intrinsic value is more than 40% greater than its December 31 share price.
The following segment was excerpted from this fund letter.
Energy Transfer Partners (NYSE:ET)
Energy Transfer Partners owns and operates the largest and most balanced collection of energy infrastructure assets in the United States. ET's assets include 125,000 miles of oil and natural gas pipelines, export facilities on both the Gulf Coast and East Coast, and more than 1 million barrels per day of natural gas liquid fractionation capacity. ET accounts for 20% of worldwide natural gas liquid exports. Further, ET is uniquely connected to every major hydrocarbon basin in the United States.
By assembling energy infrastructure to gather, process, transport, and store hydrocarbons, ET connects exploration and production companies ("E&Ps") with downstream end users such as gas stations, utilities, and export facilities. As an end-to-end midstream solution, ET enables its customers to focus on their portion of the value chain without the burden of significant but essential midstream logistics. ET's services thus add tremendous value to all constituents of the energy marketplace.
Though natural gas is a relatively clean source of fuel, restrictive federal and state regulations and other permissions severely restrict the building of natural gas pipelines and other infrastructure in North America that would help facilitate abundant hydrocarbon production. Pipelines are by far the cheapest and greenest method of transporting hydrocarbons; pipelines reduce emissions from truck transport and reduce congestion on highways, rail, and shipping routes.
Because of this restrictive environment that inhibits competition, ET is in an enviable position with decades of growth ahead secured by growing demand for American hydrocarbons. Though negative sentiment around the energy sector discourages many investors, we couldn't disagree more with their black-and-white approach to forgoing an investment in ET at today's low valuation: this is an opportunity to own essential infrastructure that facilitates global energy security and American leadership in the global transition from dirty hydrocarbons (like coal) to cleaner hydrocarbons (like natural gas).
We believe Energy Transfer Partners is an attractive investment because:
- High-quality business: ET is in an enviable competitive position having spent years assembling a large collection of synergized energy infrastructure. Future cash flows should be relatively capex- light compared to ET's historical capex needs. The nationwide footprint has been built and the company should be able to focus on accretive, high-return growth projects that further optimize ET's dense network. The company's cash flow profile is less cyclical than other companies in the energy sector, like E&Ps. Only 10% of the company's expected 2023 EBITDA is exposed to commodity price volatility: the remaining 90% is linked to fixed and volume-based fees.
- Manageable risks:
- Leverage: ET is optically highly levered at more than 4x Net Debt/EBITDA. However, ET is structured as a master limited partnership and thus does not pay corporate tax. A tax-free corporate structure results in greater free cash conversion and leverage capacity. ET's credit ratings have been rising on upgrades as the company has shown discipline by financing M&A with equity versus debt.
- Shareholder alignment: We believe one reason for ET's low valuation is management's checkered history of shareholder alignment. In particular, in 2016, Kelcy Warren, the company's founder and executive chairman, was criticized for issuing convertible preferred units to himself and a small cadre of insiders. At a high level, these special units forwent dividends for a period in exchange for favorable conversion terms. Warren argued that skipping the dividends (effectively equitizing them at a discounted price to the common units) helped the company manage a high debt burden. The episode is a clear negative, but we think Warren is now aligned with shareholders. Today, there is only one unit structure, so management is on the same footing as regular investors. ET's management owns ~11% of the company (~$5 billion in value) under this single unit structure.
- Capital allocation: ET has been a large acquirer of adjacent midstream assets. These acquisitions have significantly expanded the company, resulting in more complexity and constraints on management time. These acquisitions also resulted in the company amassing a very strategic infrastructure footprint. We believe ET's brightest days are ahead and management's M&A strategy over the last five years will prove prescient and strategic.
- Commodity cycle and politics: Unlike E&Ps whose revenues are directly linked to commodity prices, ET's exposure to the commodity cycle is linked to production and volume. If, for example, American production of hydrocarbons slowed, ET's services would be in lower demand. ET is also subject to political and regulatory risk from Presidential administrations. For example, President Biden has intended to stifle American energy production and export, whereas President Trump promulgated American energy. We believe that commodity cycle risk and political risk are somewhat mitigated by secular demand for hydrocarbons that underpin higher living standards and cleaner emissions.
- Secular tailwinds: ET benefits from secular trends in global and domestic demand for American hydrocarbons, in particular natural gas. North American natural gas export capacity should rapidly expand over the next 5 years so American producers can sell to an international market experiencing significant supply shortages. Going forward, we expect American natural gas will play a larger role in global energy consumption to achieve ambitious emissions reduction targets.
- Attractive valuation: ET trades at a TEV/EBITDA of ~8x (2023E) and ~7x (2024E) and has a mid-teens free cash flow yield. ET's valuation is lower than its peers and we believe too low for a company with an advantaged collection of energy infrastructure that provides essential services and has multiple high-return growth opportunities. We believe Energy Transfer's intrinsic value is more than 40% greater than its December 31 share price.
IMPORTANT DISCLOSURES Silver Beech Capital Management, LLC ("Silver Beech") is a New York limited liability company that serves as the investment manager to Silver Beech Capital, LP (the "Fund"), a Delaware limited partnership. The principals of Silver Beech are James Hollier, who serves as the portfolio manager and managing partner of the Fund, and James Kovacs, who serves as the managing partner of the Fund. All performance results presented herein refers to the performance of an unrestricted investor in the Fund since its inception. Net performance is presented net of the highest performance allocation in effect at the time (20%) above a 6% hurdle rate, the highest actual management fees (1.0%) charged at the time, and net of other expenses, and includes the reinvestment of all dividends, interest, and capital gains. Performance for investors who subscribed on different dates, or who pay different fees would necessarily be different from the performance presented herein. The rate of return is calculated on a "time weighted" rate of return basis, which minimizes the effect of cash flows on the investment performance of the Fund. All monthly performance data presented herein reflects unaudited data, unless otherwise specified, and as such its accuracy cannot be guaranteed. Past performance is not necessarily indicative of future results. All securities transactions involve substantial risk of loss. The material presented is compiled from sources thought to be reliable, including in certain instances, from outside sources, but accuracy and completeness cannot be guaranteed. Any opinions expressed herein reflect the judgment of Silver Beech and are subject to change. The information in this letter is for discussion purposes only. Nothing contained herein should be construed as an offer to sell, or a solicitation of an offer to buy or sell any security or investment strategy or a recommendation as to the advisability of investing in, purchasing or selling any security or investment strategy, which may only be made in the Fund's confidential offering memorandum and operative documents (collectively, the "Offering Documents"). Before making an investment decision with respect to the Fund, prospective investors are advised to read the Offering Documents carefully, which contain important information, including a description of the Fund's risks, investment program, fees, expenses, redemption and withdrawal limitations, standard of care and exculpation, etc. Prospective investors should also consult with their tax and financial advisors as well as legal counsel. The Offering Documents are the sole documents on which a potential investor is entitled to rely in evaluating an investment in the Fund. The information in this letter does not take into account the particular investment objectives, restrictions, or financial, legal or tax situation of any specific prospective investor, and an investment in the Fund may not be suitable for many prospective investors. This letter is not intended to be, nor should it be construed or used as, investment, tax or legal advice. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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