The Long and Short

Fitch upgrades Energy Transfer …is Moody’s next?

| February 9, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Energy Transfer LP (ET) was upgraded to mid-‘BBB’ this week by Fitch with the upgrade reflecting the company’s track record of keep good credit metrics while pursuing growth. ET has not only hit its leverage target, but it is expected to maintain leverage at the lower end of the range through 2024. Importantly, ET’s commercial paper rating was upgraded one notch as well. Moody’s maintains a positive outlook on ET’s ‘Baa3+’ rating and has noted the possibility of upgrade once leverage fell steadily below 4.5x and as the company reduced its interest in its Lake Charles LNG project.

An upgrade by Moody’s would put ET comfortably in the mid-‘BBB’ ratings category. Furthermore, its commercial paper rating would be upgraded to P2, providing ET with access to P2/A2 commercial paper. It would also likely serve as a spread catalyst for ET to collapse closer to its higher-rated peer Enbridge Inc. (ENB: Baa1(n)/BBB+(n)/BBB+). ENB maintains higher leverage than ET and leverage is expected to increase when the company closes its acquisition of gas distribution utilities later this year. While the acquisition may not lead to a ratings downgrade for ENBCN, it should weaken its credit profile further with ET’s leverage approximately 1.5x lower than ENBCN. That said, ET looks attractive to ENBCN, particularly in the long end of the curve (Exhibit 1).

Exhibit 1. ET compared to the ENBCN curve

Source: Bloomberg TRACE; Santander US Capital Markets

Fitch upgrades with a stable outlook

Fitch upgraded ET’s senior unsecured rating one notch to ‘BBB’ and its subordinated rating to ‘BB+’ as well as its commercial paper rating to F2. All ratings have a stable outlook. The upgrade is based on leverage that is solidly positioned for the new ratings category as well as stable EBITDA generation. Roughly 85% of ET’s EBITDA comes from fee-based activities, lending stability to the operating line. The agency also believes that ET has demonstrated its commitment to solid Investment Grade ratings given its use of equity to fund the company’s last two acquisitions. Fitch has noted that ET’s financial policies lend to flexibility and liquidity, particularly during market volatility.

ET’s liquidity is supported by a $5.0 billion unsecured revolver which matures in April 2027. The company used proceeds from its past two debt issuances, which totaled $7.0 billion, to repay the line, as well as other debt, including the Series C, D, and E preferred units. It is estimated that the facility is largely untapped. ET has $3.1 billion of debt maturing this year which has largely been refinanced.

Management committed to credit profile

ET has demonstrated that it remains committed to its credit profile and leverage given the use of equity to fund bolt on acquisitions this past year. ET completed the acquisition of Lotus Midstream in May 2023 for $1.45 billion using a combination of newly issued stock and cash on hand. The acquisition increased ET’s footprint in the Permian Basin, as it gained access to key downstream markets. Furthermore, the assets provide direct access to major hubs and the system is anchored by large cap producer customers with long-term contracts. The deal was immediately accretive to free cash flow and was leverage neutral given the lack of debt used to fund.

ET also acquired Crestwood Equity Partners LP in November 2023, in an all-stock transaction that was valued at $7.1 billion (including debt and preferreds). The acquisition further strengthened ET’s position in both the Williston and Delaware basins. Furthermore, it provided entry into the Powder River basin and catapulted ET to the largest gatherer and processor in the basin. Crestwood’s overlapping asset footprints provide for significant operational and cost synergies, thereby increasing free cash flow generation. ET is expected to utilize the increased cash flow for accelerated debt reduction, which should bring leverage closer to 4.0x by year-end 2024.

ET’s long-term capital allocation strategy is a balanced blend of shareholder returns, growth capital and debt reduction. Management has explicitly stated that it will only look to return to share buybacks when it achieves the lower end of its 4.0x-4.5x leverage target. As such, ET targets a cash flow allocation of roughly 50% to dividends, between 27%-40% for growth capital and 7-20% for debt reduction and/or share repurchases.

Exhibit 2. ET Cash Flow Breakdown

Source: ET Investor Presentation

Potential sale of Lake Charles LNG project

While no formal announcement has been made, ET noted on its last earnings call that they continue to see significant interest in the Lake Charles LNG project from both U.S. producers and international markets. At that time, management noted that they were in negotiations with several significant equity partners to reduce its interest in the project down to 20%. In January, Kyushu Electric Power Company was mulling a 10% stake in the project. ET is slated to report fiscal fourth quarter 2023 results on 2/14/24. ET will likely provide an update on a potential sale when it reports earnings as management knows that a ratings upgrade by Moody’s hinges not only on hitting its leverage target but also on a sell-down of its interest in the project below 50%.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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