My long-term financial goal is for my portfolio to generate more than enough passive income to cover my expenses. I have a long way to go. Because of that, I'm steadily buying income-producing investments.
My latest purchase was additional units of Energy Transfer (ET -2.03%). The master limited partnership (MLP) offers a big-time distribution that's on a much more sustainable foundation after the company recently achieved its target leverage ratio. Here's why I think it's an attractive option for income investors.
A monster payout
The main draw of Energy Transfer is its massive distribution. The midstream energy company currently pays out $0.305 per unit quarterly. With its unit price recently at around $12.75 apiece, that gives it an eye-popping 9.6% yield.
That payout is quite sustainable now, which wasn't always the case. Energy Transfer slashed its distributions by 50% in 2020 to retain cash for funding capital projects and debt reduction. At the time, it set a goal of returning its payout to its pre-pandemic level once the company had brought its debt-to-EBTIDA leverage ratio down into the 4.0 to 4.5 range. The MLP has steadily chipped away at its leverage while increasing its distribution over the past several quarters, and recently achieved both of those goals.
As a result, the company entered 2023 in a much stronger financial position. Even with a much higher distribution, Energy Transfer will generate enough free cash flow to cover its payout and its capital spending with room to spare. Overall, the company expects to invest $1.6 billion to $1.8 billion into expansion projects this year, a decline from the $1.93 billion it invested last year. That capital spending reduction gives it more financial flexibility. It should end 2023 with leverage toward the lower end of its target range.
The potential to continue growing
Energy Transfer has the financial flexibility to continue growing its operations. Most of its 2023 capital projects are shorter-cycle investments that should come online and contribute to cash flow this year.
However, that doesn't mean the company is running out of fuel to continue growing. It's currently working on a large-scale liquefied natural gas (LNG) export development and a petrochemical plant, among other projects. While it has experienced some delays, the company hopes to eventually approve both projects. That would enhance its long-term growth outlook. The company is also pursuing some opportunities in carbon capture and sequestration -- a potentially enormous market.
In addition, acquisitions have always been a big part of Energy Transfer's growth strategy. The company made two relatively small bolt-on acquisitions last year, buying Spindletop for $325 million and Woodford Express for $485 million. Meanwhile, it closed its $7.2 billion acquisition of Enable Midstream in late 2021, which helped fuel robust growth last year. Energy Transfer expects to continue consolidating the midstream sector, which should help enhance its growth rate in the coming years.
These growth drivers should enable Energy Transfer to continue increasing its distribution. The company plans to consider annual distribution increases after steadily boosting its payout over the past several quarters. It will balance additional cash returns to investors (which could also include unit repurchases) with investment spending while maintaining a strong financial profile.
An attractive income opportunity
Energy Transfer has come a long way over the past few years. The MLP has gotten its balance sheet back onto a solid footing, enabling it to return its distribution to its former peak. Its payout could eventually rise further as the company continues to grow its operations. Given its already high level, that upside potential adds to Energy Transfer's appeal as a passive income producer.
