ETP UPDATE

2016-02-09

As I’m sure most of you are aware, my timing on presenting Energy Transfer Partners (ETP) as a high risk speculation could not have been worse.  The stock plunged the following day when the company filed a report disclosing that CFO Jamie Welch was leaving and did so without posting a press release.  This created a significant amount of concern on the part of many investors.  Unfortunately, the water remains muddy regarding what this really means.  Therefore, I thought it would be appropriate to provide the following updates. 

However, I want it to be clear that there remain a lot of unknowns regarding what is truly transpiring.  Here are some comments and perhaps insights from the CFO Journal:

“Finance chiefs rarely depart while a merger is pending, but Energy Transfer Equity LP shares plunged 42% Monday on news CFO Jamie Welch would leave the natural gas and oil master limited partnership, in the midst of its merger with Williams Cos.

​The CFO departure attracted increased scrutiny from investors and analysts after Chesapeake Energy Corp, one of Williams’ largest clients, denied reports about planning to file for bankruptcy protection. The news further cast doubts on ETE’s merger with Williams, and the value of Williams’ contracts with Chesapeake.

‘I am just as baffled as everyone else regarding the CFO replacement,’ said Peggy Connerty, equity research analyst at Morningstar Inc, in an email.  ‘Obviously it is very concerning given the Williams deal and their need to arrange financing for it in the midst of a very challenging capital market for energy overall.’

Energy Transfer Equity and Williams Cos. in September agreed to merge in a deal that was valued at about $37.7 billion. Cratering oil, stock market weakness and concerns about how Energy Transfer would fund the cash component of the merger have led to speculation the merger will be scuttled.

A spokeswoman for Energy Transfer Equity didn’t return a phone call seeking comment.  A Williams spokesman declined comment.

Energy Transfer Equity said Thomas Long, who is CFO of Energy Transfer Partners LP, a related partnership, will assume its CFO duties, according to a late Friday securities filing . It also said it is negotiating with Mr. Welch about a potential consulting role, and his departure from the CFO role was not based on any accounting disagreements or financial matters.”

For additional color, TheStreet offered the following inputs; I think their comments about hedge funds were very interesting:

“The lack of clarity around Jamie Welch’s departure, particularly with this merger in play, is a pretty pronounced negative,’ Robert W. Baird analyst Ethan Bellamy told Bloomberg. ‘The market is in no mood to give anybody the benefit of the doubt.’

Investors are also concerned that partnership payouts will be reduced, Bloomberg Intelligence analyst Michael Kay told Bloomberg.

Further weighing on shares, Chesapeake Energy (CHK), a Williams Cos. customer, has reportedly hired lawyers to help restructure a $9.8 billion debt load.

About 13.54 million shares of Energy Transfer Partners have been traded so far today, well above the company’s average trading volume of roughly 7.25 million shares per day.”

Insight from TheStreet’s Research Team

“TheStreet’s Jim Cramer and Jack Mohr mentioned Energy Transfer Partners in a recent Action Alerts Plus post.  Here is a snippet of what they had to say about the stock:

Based on our conversations with a variety of analysts and investors, we believe the contingency driving today’s selling is heavily weighted toward hedge funds, which held close relationships with Welch and appreciated the open stream of communication he provided. Energy Transfer’s CEO Kelcy Warren is known for his calculated, cautious and tactical nature, a tone shared by the board and the rest of the company’s executive team.

While Welch’s distinctive personality attracted a new investor base — largely hedge funds with an event-driven trading mandate — we believe he simultaneously drove away the fundamental, income-oriented investors who had been hallmarks of the former shareholder base and favor consistency, security and stability.

We hope the earnings release and conference call will provide the insight, information and color needed for investors to justify owning shares for the long term. We hope Warren’s disciplined approach gradually serves to reclaim the type of fundamental investors needed for shares to trade in a more stable and reliable fashion.”

On an analysts note published January 19, 2016 MorningStar had this to say about ETP:

“ETP’s balance sheet is in better shape than many of its peers with a net debt to EBITDA ratio estimated at approximately 4.6 times for 2015 and 4.9 times for 2016. We forecast EBITDA to interest at 4.5 and 4.4 times in 2015 and 2016, respectively. With a large capital expenditure backlog in place, ETP will need to balance funding this backlog with paying its distribution where coverage is already quite poor. This is a daunting task, particularly in the context of a depressed energy market and curtailed capital markets for midstream operators. If the Energy Transfer-Williams merger closes, we expect synergies on both the operation and commercial fronts to benefit ETP’s overall long-term health, particularly for assets in the Marcellus and Utica shale areas.

From 2005 to 2008, Energy Transfer built itself into a major master limited partnership through a steady build-out of large-diameter natural gas pipelines, providing access to markets for the shale gas bonanza. When gas prices collapsed, Energy Transfer’s cash flow growth did, too, and distribution growth flatlined. To remedy this situation, Energy Transfer executed a massive strategic shift, and the partnership is now diversified across the midstream value chain.

Any investment thesis for Energy Transfer needs to account for its strategic shift, and investors also need to understand that there are a few more shifts to come, such as the acquisition of Regency announced in early 2015. Energy Transfer Equity’s acquisition of Southern Union and Energy Transfer Partners’ purchase of Sunoco have expanded and strengthened its asset base, business model, and cash generation capacity. Recent transactions between ETP and its general partner Energy Transfer Equity have reduced ETP units outstanding, giving a boost to distribution coverage and supporting renewed distribution growth. The Susser acquisition gives ETP a path to monetizing its retail business acquired with Sunoco, which is likely to entail a series of drop-down transactions and the exchange of Susser incentive distribution rights for ETP stock still held by ETE, lessening units outstanding.

Next up, investors should focus on the impact of two massive pipeline projects slated to come on line in 2016 and 2017. The ET Rover gas pipeline will move 3.25 billion cubic feet per day of Marcellus and Utica gas west and north, providing needed market access. The Dakota Access crude oil project will move 320 thousand-540 thousand barrels of crude oil a day from the Bakken shale in North Dakota to Patoka, Illinois, where interconnects with ET’s Trunkline pipeline will provide access to the Gulf Coast. Both projects are moving forward and will add a significant jolt of long-term, fee-based cash flows to Energy Transfer, widening its moat.”

And MorningStar expressed a vote of confidence for the company’s management team as follows:

“Management 01/18/2016

We think highly of Energy Transfer’s management. Kelcy Warren is CEO and chairman of Energy Transfer Partners and chairman of Energy Transfer Equity, the general partner of Energy Transfer Partners. Operational head Mackie McCrea is president and COO and has been with the company since 1997. Energy Transfer Equity has reduced its ownership of ETP’s limited partner units to around 10 million units through a series of intercompany asset transactions, but retains a 0.9% general partner stake and all of its incentive distribution rights. IDRs provide the general partner with an increasing percentage of the quarterly cash distributions after the minimum quarterly distribution has been paid. This motivates the general partner to increase distributions well above the current annualized payout of $3.98 per unit, and limited partner unit holders will benefit from these potential increases. As at many MLPs, limited partners have limited voting rights and a supermajority is required to oust the general partner. Our biggest stewardship concerns are ETP’s acquisitive nature, which opens up the risk of overpaying for assets, and the complexity of the partnership structures, which makes tracing cash flows through the entities challenging.”

Conclusion

I still consider ETP an intriguing speculation, and in light of what happened yesterday, from a valuation standpoint perhaps compelling.  However, this is a high risk situation and there is still more to be learned about the company’s current situation.  If the William’s merger does in fact go through, I believe the long-term opportunity is extraordinary.  In contrast, if the merger falls apart, I don’t believe it’s the end of the world for ETP.  On January 27, 2016 ETP declared a regular $1.055 per-share quarterly dividend which I consider a good sign.  On the other hand, it is only speculation on my part as to what might happen in future quarters.  Caveat emptor (buyers beware).

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