Energy Transfer LP

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 2/5

Energy Transfer LP is a Delaware limited partnership that owns and operates a diverse portfolio of energy assets, primarily in natural gas, and also in crude oil and refined products transportation and storage.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Moat Analysis: ET’s moat is complex to analyze due to the nature of its infrastructure assets. Here’s how I’d break down its competitive advantages:

1. Infrastructure as a Barrier to Entry (Narrow Moat):

  • ET owns an extensive network of pipelines, processing plants, and storage facilities, many of which are strategically located. This creates a significant barrier to entry, because building a competing network would require immense capital and time, as well as facing a complex regulatory environment.
  • The company is heavily integrated with producers and customers, enabling the transportation of products for long periods. Most long term contracts and a highly interconnected system of pipelines makes it hard to replace them with an equal level of efficiency.

However, note that this network is a double edged sword. Although extensive, it also means that ET is very sensitive to changes in production levels and industry structure.

2. Location-Based Advantage (Narrow Moat):

  • ET’s assets are strategically located, typically where energy supply is concentrated—in high producing natural gas regions (Appalachia, Permian, Haynesville, and others) and oil production centers and transportation hubs, creating an advantage that reduces transportation costs for its customers.
  • Proximity to these centers reduces its transportation costs and gives it a competitive edge compared to competitors located further away from these regions.

However, note that this advantage is not extremely strong because there are still multiple competitors located within the same areas with more efficient means of transportation.

3. Scale Efficiencies (Weak Moat):

  • ET’s large-scale operations allow it to transport large volumes of energy with lower per-unit costs and offer its customers a variety of services with a single counter-party contract.
  • However, it’s worth noting that while this scale may produce cost savings for its customers, there are other companies that have very similar capacities.

Moat Rating: 3/5 While ET’s infrastructure and strategic locations provide some barriers to entry, it faces increased competition and regulatory challenges. These have been exacerbated by the company’s relatively high debt leverage. Therefore, it receives a rating of 3 out of 5, indicating a Narrow Moat that is not the most robust or sustainable.

Risks Affecting the Moat and Business Resilience:

  1. Regulatory Changes: ET operates in a highly regulated industry, and any change in legislation—including environmental laws, safety requirements, or tariff policies—can negatively impact profitability and growth.
  2. Commodity Price Volatility: Because the company’s revenues are tied to energy prices, fluctuations can cause wide swings in revenue, earnings and cash flows. These are outside of ET’s control and can make financial projections more difficult.
  3. Counterparty Risk: ET relies heavily on contracts with other energy companies. If those contracts are breached for any reason or companies default on their obligations it will negatively impact revenues.
  4. Environmental Concerns: New or ongoing environmental concerns regarding emissions and the use of fossil fuels may cause significant disruptions in its business.
  5. Operational Mishaps: Oil spills and explosions, or similar mishaps in any of its assets may cause tremendous loss of life, financial harm and legal implications to the business.
  6. Technology Obsolescence: Emergence of new sources of energy or innovative tech in energy transportation might make ET’s existing assets less valuable.
  7. Macroeconomic Conditions: Downturn in the economy may decrease demand for the energy products it transports.
  8. Debt Burden and Financial Instability: ET’s financial results are heavily leveraged by debt and it is a potential risk factor for default.

Despite these risks, the diversified nature of ET’s businesses, extensive network, and strong counterparties, combined with its long term contracts, provides some financial resilience. However, a big negative event could cause an almost irreversible impact on this highly leveraged business.

Business Overview:

  • Revenue Distribution:
    • The partnership primarily generates income from the following sources:
      • Natural Gas Transportation and Storage: This segment accounts for the bulk of ET’s revenues. This part includes pipelines, compressor stations, and storage facilities that connect production basins to consumption markets.
      • Crude Oil Transportation and Services: ET engages in oil transportation through pipelines and other facilities, and also provides gathering, storing, and processing services.
      • NGL and Refined Products Transportation and Services: This segment includes pipelines and storage facilities used to transport Natural gas liquids and refined petroleum products such as gasoline, diesel, jet fuel, etc.
      • Other: A minor portion of revenues is from terminaling services.

  • Industry Trends: * Long term energy trends show the shift away from coal and oil toward natural gas. This shift is expected to increase demand for natural gas in the coming decade. * The world is slowly moving toward renewable energy, but still the dependence on fossil fuels is very high. This situation gives time for Energy Transfer to pivot operations to a more renewable direction as those industries rise, and potentially make use of its existing distribution networks for newer fuel sources. * Many countries around the world are investing heavily in energy infrastructure, which presents new investment possibilities for companies like Energy Transfer.

  • Margins:
  • ET’s margins are relatively good, due to its contracts that allow it to earn a fee regardless of the current state of the commodity markets. Although operating margins are healthy, the debt situation does have a great effect on net income.
  • Margins fluctuate depending on commodity price volatility. If prices are high, and volumes are also high, the company stands to make tremendous profits. But if energy prices drop or volumes of transportation decrease significantly, it could negatively affect the income.
  **However, its ability to generate huge profits are sometimes tempered by its long term contractual debt.**
  • Competitive Landscape:
    • The pipeline and infrastructure businesses are competitive with many other players. A large portion of the pipeline assets, including crude oil pipelines, is being acquired by smaller and newly formed companies or by other large companies who have a better balance sheet.
    • Natural gas transport and logistics segment is dominated by few major players like Kinder Morgan, Enbridge etc. These companies are often better funded and more financially stable than Energy Transfer.
  **While a large network is a moat, its not the greatest in the business. ET does face considerable competition from other pipeline companies.**
  • What Makes ET Different:
    • Energy Transfer’s diversification across the oil and gas value chain and its geographic diversity gives it a slight edge.
    • ET has a unique combination of assets, including natural gas, oil, and NGL infrastructure, enabling it to serve a variety of customer needs and thus increase flexibility in its operations. However, that also has created a complex business.

Financials Deep Dive:

  1. Revenues: Energy Transfer LP’s revenues are largely driven by the volume of energy transported and stored. In recent years, the company has been impacted by fluctuating energy prices and volumes. The trend shows an increase in revenue from 2020 to 2021, but the company saw declines in 2022.
  2. Operating Expenses: Operating expenses include operating, maintenance, gathering, and other overhead costs associated with its extensive infrastructure. These expenses have increased due to inflation and rising costs of operations.
  3. Net Income: Net income was negative in 2020, but recovered in 2021 as prices for energy soared. In 2022, despite higher revenue, ET’s earnings took a hit from its losses on derivatives, impairments, write-offs, and increased interest expenses. This results in fluctuations that are largely beyond its control. The increase in interest expenses is due to its massive debt load and the fact that the interest rates are rising.

While some may seem like one-time expenses, but they are a recurring factor in this volatile industry and must be taken into account when valuing the company.

  1. Debt: Energy Transfer is a highly leveraged company with considerable amount of debt burden, both short and long term. Interest payments on this debt also put a strain on profitability. A huge increase in debt also came from acquiring other businesses. This high leverage may increase its exposure to risks in a downturn and must be considered.
  2. Cash Flow: Operating cash flow is inconsistent and often fluctuates based on its earnings and changes in working capital, as seen in 2022 when its cash flow decreased.
  3. Capital Expenditures: Capital expenditures are substantial as it has to continually invest in new infrastructure and maintain existing ones. ET spends money on pipelines, storage facilities, and other expansion opportunities. It is difficult for a company in such a sector to maintain a good ROIC without significant capital expenditure, as can be seen in its income statements.

Even though the company has had great profits from 2021 and before, the sheer size of capital expenditures have caused a lot of cash outflow and this is likely to continue.

  1. Goodwill and Intangible Assets:
    • The total goodwill and intangible assets for Energy Transfer stand around $13 billion and this is from the company’s many acquisitions.
    • Since the goodwill and intangibles aren’t depreciated, the value that the company receives from them has to be measured by looking at the ROIC.

Value creation is only possible if ROIC excluding goodwill and intangibles exceeds its weighted average cost of capital.

  1. Recent Earnings Call:
    • In the recent earnings calls, management has stated a positive outlook for its future results and believes that it has a strong business model that can generate profits even in the current economic conditions.
    • Energy Transfer also noted the potential for expansion through its existing pipelines through the use of natural gas.
    • Management also noted the progress on various new projects, and their confidence to reach their growth targets.

However, note that these comments by the management are expected and should not be treated as facts, since management’s main priority is usually to instill confidence in the company by the investors. This is especially true when their previous projections have sometimes failed to meet their estimates.

Understandability Rating: 4/5 While ET operates in a relatively simple industry (energy transportation and storage), the scale of its operations and the complex nature of its financial statements make it relatively harder to completely comprehend than other similar companies. Therefore, I rate it as a 4 out of 5 in the understandability scale.

Balance Sheet Health: 2/5 ET’s balance sheet is not in great shape due to large amounts of debt and volatile operating performance, which in turn affects cash flow. Although assets are present, their quality may be questionable and a significant portion of it is in the form of goodwill. Therefore, it receives a balance sheet rating of 2/5, which makes it a high risk for investment if not bought at attractive valuation.