Energy Transfer Q4 2022 Earnings Preview: What To Watch For (NYSE:ET)

After the market closes on February 13th, the management team at midstream and pipeline operator Energy Transfer (NYSE:ET) is slated to report financial results covering the final quarter of the company’s 2022 fiscal year. In recent months, shares of the company have roared higher, driven by the fact that the stock looks cheap and by the robust cash flows the company has achieved. But in this kind of market, fundamental health can change on a dime. Because of this, there are a few things that investors should be paying attention to leading up to and during the earnings release. But absent anything significant changing for the worse, I would make the case that shares offer further upside for investors from here. Certainly enough upside to keep the ‘strong buy’ rating I had on the stock previously.

Keep an eye on major metrics

The last article I wrote about Energy Transfer was published in early November of 2022. In that article, I talked about both the surprises and disappointments that the company revealed in its third quarter earnings release. Where it counted, the company did perform exceptionally well, particularly when it came to cash flows and debt reduction. But the overall picture could have been better. The good news is that shares of the company were still very cheap, leading me to keep the ‘strong buy’ rating I have on the stock previously. Because of the mixed financial results reported for the third quarter, and likely because of broader economic concerns, shares have not performed particularly well. Since the publication of that article, the stock is up only 4.9% compared to the 8.7% upside experienced by the S&P 500. Although it is worth mentioning that most of my calls on the company have been accurate. For instance, since writing about the company favorably in October of 2022, shares have generated a return of 207.8% compared to the 25.7% upside seen by the market over that same window of time.

As we saw in the last article I wrote about the company, results reported for a business can have consequences at last for months or even longer. That’s why investors should be paying attention to what the company reports in the coming days. Because of the nature of this particular firm, I don’t believe that the most-watched metrics like revenue and earnings per share are all that important. But initially, the market will be paying attention to those. The current expectation is for the company to generate revenue of $23.81 billion, while earnings per share should be around $0.37. For context, during the final quarter of its 2021 fiscal year, the company reported revenue of $18.66 billion and earnings per share of $0.29.

More important will be certain cash flow metrics that the company announces. One of these will be operating cash flow. During the final quarter of 2021, this metric came in at $3.45 billion. However, if we adjust for changes in working capital, it would have come in lower at $2.66 billion. Another metric is what I refer to as ‘true free cash flow’. In short, it is adjusted operating cash flow minus the capital expenditures needed to keep current operations where they are in perpetuity. This number came in at $2.45 billion during the fourth quarter of 2021. DCF (distributable cash flow), meanwhile, was lower at $1.60 billion, while EBITDA came in at $2.82 billion. These metrics are the true determinants of exactly how the company is performing from quarter to quarter or from year to year. Given the fact that the company has a tremendous amount of exposure to natural gas, the recent plunge in natural gas prices might have some investors worried. However, as of the end of the third quarter, the company estimated that between 85% and 90% of the EBITDA it expected to generate for all of 2022 would be based on fees as opposed to commodity fluctuations. Commodity fluctuations were expected to account for between 10% and 12.5% of EBITDA, while the spread in pricing for products was expected to account for the remaining 0% to 2.5%.

In addition to various cash flow metrics, it would also be wise for investors to keep an eye on the company’s debt situation. For each of the three most recent quarters for which data is available, the company saw a reduction in net debt from quarter to quarter. As of the end of the third quarter, this came in at $47.09 billion. That’s down $2.28 billion from the final quarter of the company’s 2021 fiscal year and it’s down $3.98 billion from the final quarter of 2020. Currently, the company does have a net leverage ratio of 3.65. This is not awful by any means. But seeing the number fall further would be incredibly bullish.

Pay attention to guidance for 2023

It’s highly probable that management will announce guidance for the 2023 fiscal year when they report financial results for the final quarter of 2022. Assuming that the market believes what management says, the guidance offered will likely be the most important item that comes from this earnings release. Given the massive investments the company has allocated toward growth, including growth capital expenditures for 2022 of between $1.80 billion and $2.10 billion, there will likely be the expectation that this year will be better than the last. One good sign that this could come to pass was announced on January 25th when management said that they were raising their distribution once again. The current distribution comes out to $0.305, or $1.22 per year. The quarterly amount is up 15% compared to the third quarter number and it’s up around 75% year over year. This also, at current pricing, gives the company a rather hefty yield of 9.4%. That’s within striking distance of what the average return has been (about 11.4%), historically speaking, for the S&P 500.

Shares still look cheap

In addition to generating stable and steadily growing cash flows, the other thing that I like about Energy Transfer is the fact that shares of the company look very cheap. Previously, I calculated what the aforementioned cash flow metrics for the company should look like for 2022 as a whole. I also made some modifications to adjusted operating cash flow and ‘true free cash flow’ to strip out preferred distributions and non-controlling interests from the picture. The end result can be seen in the chart above. The chart below shows the pricing for the firm.

As part of my analysis, I ended up comparing Energy Transfer to five similar firms. I did this using two of the four metrics in the aforementioned chart. On a price to adjusted operating cash flow basis, these companies range from a low of 4.7 to a high of 8.6. Energy Transfer was the cheapest of the group. Meanwhile, using the EV to EBITDA approach, the range was from 5.9 to 391.2. In this case, only one of the five companies was cheaper than our target.

Company	Price / Operating Cash Flow	EV / EBITDA
Energy Transfer	4.2	7.9
Williams Companies (WMB)	8.1	11.6
Kinder Morgan (KMI)	8.5	13.0
Cheniere Energy (LNG)	4.7	391.2
MPLX LP (MPLX)	6.9	5.9
TC Energy (TRP)	8.6	12.0

Click to enlarge

To see what kind of upside potential might exist for shareholders, I also decided to price the company as though it were trading at levels more similar to its peers. I did this using two different approaches. The more conservative approach compared Energy Transfer to the cheapest of its peers listed, while the more liberal approach used the average multiples of the five peers and applied that multiple to our prospect. For full transparency, I removed the most expensive company for the EV to EBITDA approach because of how much of a massive outlier it was. Using the price to operating cash flow basis, we would get upside of between 11.9% and 75.2%. Meanwhile, when it comes to the EV to EBITDA approach, we would see downside of as much as 63.3% and upside of 88.8%. It is worth mentioning, however, that if we remove the lowest of its peers when it comes to the EV to EBITDA approach, the next lowest would imply upside of 120.1%, while the average would move up to allow upside of 139.4%.

Takeaway

Energy Transfer seems to me, at this time, to still be in fantastic shape. Naturally, that picture could change. But based on the data available, I think that the chance of the picture worsening is incredibly small. While it is true that the past few months have seen shares underperform the market more broadly, the company is incredibly healthy and it’s likely to generate market-beating returns in the long run. Because of this, I have no problem keeping it as a ‘strong buy’ candidate and, even though I am in the process of moving around my portfolio to some degree, I have no plans of selling my Energy Transfer stake for the foreseeable future.